Fiscal Reforms Are Critical for Economic Stability, Sustainable Growth in Pakistan

ISLAMABAD —Pakistan’s economy slowed sharply in FY23 with real GDP estimated to have contracted by 0.6%. According to the World Bank’s latest Pakistan Development Update: Restoring Fiscal Sustainability, released today, the decline in economic activity reflects the cumulation of domestic and external shocks including the floods of 2022, government restrictions on imports and capital flows, domestic political uncertainty, surging world commodity prices, and tighter global financing.

The previous fiscal year ended with significant pressure on domestic prices, fiscal and external accounts and exchange rate, and loss of investor confidence. The difficult economic conditions along with record high energy and food prices, lower incomes, and the loss of crops and livestock due to the 2022 floods, have significantly increased poverty. The poverty headcount is estimated to have reached 39.4% in FY23, with 12.5 million more Pakistanis falling below the Lower-Middle Income Country poverty threshold (US$3.65/day 2017 PPP per capita) relative to 34.2% in FY22.

“Careful economic management and deep structural reforms will be required to ensure macroeconomic stability and growth,” said Najy Benhassine, World Bank Country Director for Pakistan. “With inflation at record highs, rising electricity prices, severe climate shocks, and insufficient public resources to finance human development investments and climate adaptation, it is imperative that critical reforms are undertaken to build the fiscal space and public means to invest into inclusive, sustainable, and climate-resilient development.”

Without a sharp fiscal adjustment and decisive implementation of broad-based reforms, Pakistan’s economy will remain vulnerable to domestic and external shocks. Predicated on the robust implementation of the IMF Stand-By Arrangement (SBA), new external financing and continued fiscal restraint, real GDP growth is projected to recover to 1.7% in FY24 and 2.4% in FY25. Economic growth is therefore expected to remain below potential over the medium term with some improvements in investment and exports.

According to the report, limited easing of import restrictions thanks to new external inflows will widen the current account deficit in the near term and weaker currency and higher domestic energy prices will maintain inflationary pressures. While the primary deficit is expected to narrow as fiscal consolidation takes hold, the overall fiscal deficit will decline only marginally due to substantially higher interest payments. The economic outlook is subject to extremely high downside risks, including liquidity challenges to service debt payments, ongoing political uncertainty, and external shocks.

“These macroeconomic challenges can be addressed through comprehensive fiscal reforms of tax policy, rationalization of public expenditure, better management of public debt, and stronger inter-government coordination on fiscal issues. The deepening of reform efforts to regain fiscal and debt sustainability are imperative for a longer-term recovery,” said Aroub Farooq, Economist at the World Bank, and author of the report.

To regain stability and establish a base for medium-term recovery, the report recommends reforms to drastically reduce tax exemptions and broaden the tax base through higher taxes on agriculture, property and retailers; improve the quality of public expenditure by reducing distortive subsidies, improving the financial viability of the energy sector, and increasing private participation in state-owned enterprises; and strengthening management of public debt through better institutions and systems, and by developing a domestic debt market.

The Pakistan Development Update is a companion piece to the South Asia Development Update, a twice-a-year World Bank report that examines economic developments and prospects in the South Asia region and analyzes policy challenges faced by countries. The October 2023 edition titled Toward Faster, Cleaner Growth shows growth in South Asia is higher than any other developing country region in the world, but slower than its pre-pandemic pace and not fast enough to meet its development goals. The report also includes short and long-term policy recommendations for countries in the region to manage fiscal risks and accelerate growth, including by boosting private sector investment and seizing opportunities created by the global energy transition.