Pakistan's economy faces severe headwinds with mounting deficits, high inflation

"This combination of low growth, high inflation and low levels of official foreign exchange reserves are the key challenges for policymakers,” alerted the MoF on December 30.

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Pakistan’s economic situation is facing "severe headwinds" with inflation being forecast to stay high between 21-23% and the cash-strapped country's fiscal deficit widening by more than 115% in the first four months (July-October) of the current fiscal year.

Pakistan's Ministry of Finance (MoF) in its Monthly Economic Update and Outlook said that the economic growth is likely to remain below the budgeted target in FY23 due to devastation caused by floods, the Dawn newspaper reported.

"This combination of low growth, high inflation and low levels of official foreign exchange reserves are the key challenges for policymakers,” alerted the MoF on December 30.

According to the MoF report, the overall fiscal deficit stood at 1.5% of GDP (Pakistani Rs. 1.266 trillion) during July-October 2022-23 as compared to 0.9% of GDP (Rs.587 billion) last year.

The fiscal deterioration was because of higher expenditure growth on the back of higher markup payments while the government is facing the unprecedented challenge of providing relief to people in flood-hit areas.

It said the average Consumer Price Index (CPI) in the first five months (July-November) of FY23 remained 25.1% compared to 9.3% in the same period last year. “It is expected that CPI inflation will remain in the range of 21-23%," it said.

The current account posted a deficit of $3.1 billion for July-November FY23 against a deficit of $7.2 billion last year, mainly due to an improvement in the trade balance. The current account deficit (CAD) shrank to $276 million in November as against $569 million in October.

Talking about the industrial sector, the MoF also conceded downward trends. Industrial activity, measured by the large-scale manufacturing (LSM) index output, came in somewhat lower than expected in October as the sector was the most exposed to external conditions, the newspaper reported.

The situation on the LSM front has been attributed to several factors. Firstly, the weighted average cyclical output gap in Pakistan’s main trading partners remains in negative territory and continues to widen gradually, which implies a reduction of global demand.

Secondly, the impact of floods-induced destruction of agricultural output may start finding its way into the industrial sectors. Thirdly, Pakistan’s official foreign exchange reserves are at relatively low levels, necessitating restrictive monetary policy and other measures to limit imports.

The MoF expected the pressure on LSM likely to be sustained in November if the negative shocks are continuing to prevail and outpace the LSM output which may gain some momentum as sugarcane crushing starts in November.

The balance of payments data indicates that exports of goods and services increased by around 1.9% in November as compared to October. Exports have now settled around $2.9 billion and are expected to climb further to $3 billion in the coming months. However, on a year-on-year basis, exports decreased by 12.7%.

November’s balance of payments data further witnessed that the import of goods and services fell by 5.9% month-on-month and a massive decline of 32% year-on-year.

Contained domestic demand and higher domestic interest rates reflect low imports for machinery, transport, textile, agri and other chemicals and metal groups. It is expected that imports will settle at further lower levels gradually in the coming months.