Pakistan’s Gross Domestic Product (GDP) growth slowed as economic policies to address the twin deficits took effect. Growth slowed to 3.3 percent in FY19—a 2.2 percentage points decline compared to the previous year, due to the stabilization measures undertaken by the authorities. Over the past year, the exchange rate was allowed to depreciate, with a cumulative depreciation of 25.5 percent, the development budget was cut, energy prices were increased, and the policy rate was raised by 575 bps. As a result, private consumption growth decelerated from 6.8 percent in FY18 to 4.1 percent in FY19 while investment contracted by 8.9 percent. On the supply side, the industrial sector growth slowed to 1.4 percent in FY19 compared to 4.9 percent in FY18. The services sector grew at 4.7 percent—1.5 percent lower than in FY18. Adverse weather conditions have dampened agricultural performance and reduced growth to 0.8 percent in FY19, significantly lower than the targeted growth of 3.8 percent. Average headline inflation increased to 7.3 percent in FY19 compared with 3.9 percent in FY18, primarily because of the exchange rate passthrough.
The Current Account Deficit (CAD) declined. The CAD narrowed to US$13.5 billion (4.8 percent of GDP) in FY19 compared to US$19.9 billion (6.3 percent of GDP) in FY18. The decline was primarily driven by lower import growth (goods imports declined by 7.4 percent while services imports fell by 14.9 percent). The largest decline in imports was for transport and machineries, because of the slowdown in investment and industrial growth, followed by food items and metals. However, petroleum related imports continued to grow (5.0 percent), albeit at a lower rate than last year (25 percent). Exports, on the other hand, did not respond to the exchange rate depreciation, as regaining competitiveness after an extended period of an overvalued exchange rate will take time. The growth in remittances by 9.7 percent year-on-year in FY19, due to higher flows from USA, Malaysia, and GCC countries, also supported the current account. The narrowing of the CAD has continued in FY20, as the CAD declined to US$1.3 billion in Jul-Aug FY20, compared to US$2.9 billion in Jul-Aug FY19. Imports declined by 23.4 percent year-on-year in Jul-Aug FY20, while exports recorded a marginal recovery of 1.4 percent year-on-year.
Aided by bilateral, IMF, and other multilateral flows, international reserves have started to recover. Financial flows had a boost in FY19 due to a significant increase in central bank deposits and bilateral inflows from China, UAE and Saudi Arabia. The approval of the IMF Extended Fund Facility in July 2019 coupled with the resumption of multilateral budget support have contributed to an increase in the international reserves to US$9.4 billion (1.9 months of import coverage) in September 2019 compared to US$7.6 billion (1.6 months of import coverage) in January 2019. The gradual accumulation of reserves is also being supported by reduced pressures on the exchange rate.
The fiscal deficit (including grants) increased to 8.8 percent of GDP in FY19 from 6.4 percent in FY18. The higher deficit was primarily due to revenue underperformance and higher interest payments. Tax revenues, at both the federal and the provincial level, stagnated at last year’s level. In addition, non-tax revenues declined by 44 percent as the exchange rate depreciation reduced the profits of the State Bank of Pakistan (SBP), resulting in lower transfers to the government. As a result, overall revenues contracted by 6.3 percent. Total expenditures increased by 11.5 percent year-on-year in FY19, as current expenditures increased by 21 percent driven by the almost 40 percent increase in interest expenditures, year-on-year. Development spending was curtailed by 25 percent year-on-year in FY19, as the federal and provincial governments attempted to adjust their fiscal balances.
Public debt increased during FY19, primarily because of the exchange rate depreciation. Pakistan’s public debt (comprising general government and State-Owned Enterprises (SOE) external debt) stood at 86.5 percent of GDP at end-June 2019—13.5 percentage points higher than end-June 2018. The debt level is in breach of the Fiscal Responsibility and Debt Limitation Act (FRDLA) 2005 (amended in 2017) that stipulates a reduction of total public debt to 60 percent of GDP by end-FY18. The increase in public debt was primarily driven by the depreciation of the Pakistani rupee (PKR) against the US dollar in FY19. External debt accounts for 37.9 percent of the total and is held by multilaterals (44.2 percent), bilaterals (34.3 percent), commercial creditors including international bonds (20.0 percent) and others (1.6 percent).
Real GDP growth is projected to decelerate to 2.4 percent in FY20 as the government tightens fiscal and monetary policies. Pakistan’s adjustment entails a rebalancing from domestic to external demand. While domestic demand will slow down quickly, net exports are expected to increase gradually. Growth is expected to recover gradually to 3.0 percent in FY21 as external demand picks up, macroeconomic conditions improve, and the package of structural reforms in fiscal management and competitiveness take effect. This recovery is conditional on relatively stable oil prices and reduced risks. Inflation is expected to increase slightly in FY20, driven by the second-round impact of exchange-rate pass-through to domestic prices. Thereafter, inflation is projected to decline gradually.
 The amendment to the FRDLA also stipulates a reduction of total public debt by 0.5 percent each year from FY19-FY23 and by 0.75 percent each year from FY24-FY33 after which public debt would be maintained at a level of 50 percent of GDP or less.
Last Updated: Oct 21, 2019