Pakistan’s Economy and Challenges

Pakistan is experiencing severe economic challenges reflecting long-standing structural we
aknesses. Pakistan made significant progress towards reducing poverty between 2001 and 2018 when the expansion of off-farm economic opportunities and increased inflow of remittances allowed over 47 million Pakistanis to rise out of poverty. However, this rapid poverty reduction has not fully translated into improved socio-economic conditions, as human capital outcomes have remained poor and stagnant, with high levels of stunting at 38 percent and learning poverty at 75 percent. In addition, reflecting a consumption-driven growth model, with limited productivity-enhancing investment and exports, strong economic growth often comes at a cost of economic imbalances and frequent macroeconomic crises. Long-term growth of real gross domestic product (GDP) per capita therefore has been low, averaging only around 2.2 percent annually over 2000-22.

Pakistan’s economy is currently under severe stress with low foreign reserves, a depreciating currency, and high inflation. With high public consumption, economic growth increased substantively above potential in FY22 that led to strong pressures on domestic prices, external and fiscal sectors, the exchange rate, and foreign reserves. These imbalances were exacerbated by the catastrophic flooding in 2022, surging world commodity prices, tightening global financing conditions, and domestic political uncertainty. Furthermore, distortive policy measures, including periods of informal exchange rate restrictions and import controls, delayed the IMF-EFF program, and contributed to creditworthiness downgrades, lower confidence, high yields and interest payments, and the loss of access to international capital markets.

Economic activity has fallen with policy tightening, flood impacts, import controls, high borrowing and fuel costs, low confidence, and protracted policy and political uncertainty. The devastating floods, along with difficulties in securing quality fertilizers and animal feed, have reduced agricultural output and labor opportunities for low-income workers. Similarly, dwindling foreign reserves, import restrictions, flood impacts, high fuel costs, policy uncertainty, and the slowdown in domestic and global demand have affected industry and service sector activity. With the destruction of infrastructure and disrupted access to schools, medical facilities, and sanitation systems, the floods have negatively impacted health and education outcomes especially for rural areas, potentially affecting long-term human capital accumulation.

Economic growth is expected to slow and remain below potential in the medium-term. Real GDP growth is expected to slow sharply to 0.4 percent in FY23, reflecting corrective tighter fiscal policy, flood impacts, high inflation, high energy prices and import controls. Agricultural output is expected to contract for the first time in more than 20 years due to the floods. Industry output is also expected to shrink with supply chain disruptions, weakened confidence, higher borrowing costs and fuel prices, and heightened uncertainty. The lower activity is expected to spill over to the wholesale and transportation services sectors, weighing on services output growth. Predicated on completion of the IMF program and sound macroeconomic management, output growth is expected to gradually recover in FY24 and FY25 but remain below potential as low foreign reserves and import controls continue to curtail growth. In the absence of higher social spending, the lower middle-income poverty rate is expected to increase to 37.2 percent in FY23. Given poor households’ dependency on agriculture, and small-scale manufacturing and construction activity, they remain vulnerable to economic and climate shocks.

The Government faces a difficult policy challenge in maintaining progress towards macroeconomic stabilization. The economic outlook is dependent on timely and full implementation of policy reforms, with very high downside risks. Implementing the macro-stabilization measures and structural reforms underpinned by the IMF-EFF program is necessary for unlocking much-needed external refinancing and new disbursements from regional partners. Maintaining stability and a sustained recovery will require the development, communication, and effective implementation of a bold reform strategy, including: i) adherence to a flexible market-determined exchange rate and sound fiscal-monetary policies; ii) increased domestic revenue mobilization; iii) curtailing and improving the quality of public expenditures; iv) structural reforms to improve investment, competitiveness, and productivity; and v) urgent measures to restore the financial viability of the energy sector.