Country briefing note <download pdf file>
Growth remains low due to both external and domestic factors
- The economy of Pakistan is passing through a phase of low growth. However, there was improved performance in 2012 despite numerous challenges, including heavy rain and flooding in southern parts of the country, increases in fuel and commodity prices, the global slowdown and weak capital inflows.
- GDP grew by 3.7% in 2012 as compared with 3% in 2011. The agricultural sector performed better than in 2011. As for manufacturing, its performance improved. The construction sector staged a strong recovery. Higher growth in the industrial sector as a whole was achieved despite shortages of electricity and natural gas. On the other hand, the services sector witnessed somewhat slower growth.
- On the demand side, consumption, both private and public, grew at a higher rate in 2012 but investment declined. As a result, investment fell to 12.5% of GDP in 2012 from 13.1% of GDP in 2011.
- The protracted energy crisis and weak fiscal fundamentals are the main reasons behind slow growth. Similarly, the declining trend in private investment expenditures is continuing. Without stemming the free fall in investment and addressing the challenge of chronic energy shortages, growth cannot be improved on a sustainable basis. In Pakistan, GDP growth is projected to be 3.5% in 2013.
High inflation persists
- The persistence of high inflation in Pakistan is primarily due to entrenched expectations of inflation remaining high. It seems that the key drivers for this expectation are continued fiscal borrowings from the central bank and feared depreciation in the exchange rate even though the external current account deficit is modest.
- However, inflation in Pakistan was brought down from 13.7% in 2011 to 11% in 2012. This was achieved despite increases in international oil prices, the effect of an upward adjustment in the administered prices of electricity and natural gas, supply disruptions due to heavy rains and flooding in the southern part of the country and heavy bank borrowings.
Monetary policy needs to strike a balance between curbing inflationary expectations and reviving growth
- Countries in the subregion are facing serious challenges of slowing down of economic growth and at the same time to contain high inflationary pressures. Therefore, some countries have started to ease monetary policy to support private investment and growth. Pakistan lowered its policy rate by 150 basis points in October 2011 and again by the same magnitude in August 2012. With some slowing in inflation, the reduction in the policy rate continued in October and December 2012, when the policy rate was further lowered by 50 basis points each time to enhance the extension of credit to the private sector.
Budget deficit continues to remain high
- The Government of Pakistan finds it difficult to contain the budget deficit, estimated at 8.5% of GDP in 2012 against 6.6% of GDP in 2011. To contain budget deficit, Government continued its efforts to broaden the tax base and simplifying the tax structure. Efforts are underway to move towards two main taxes, i.e. income tax and sales tax.
- However, policy of continued large subsidies to the energy and other sectors as well as to preserve the safety nets for the vulnerable groups, have added to government expenditures. Solving energy sector problems will help macroeconomic stability through improving GDP growth, higher revenues and less subsidy expenditures.
Current account surplus in 2011 returns to deficit
- Pakistan achieved strong export growth at 28% in 2011 and value of total merchandise exports reached $25 billion. Despite the crisis in the euro zone, a major destination for Pakistan's exports, the country could maintain exports at nearly the same level as in the previous year. This implies a marginal negative growth of exports in 2012. Imports grew by 15%, primarily due to higher volumes of oil and fertilizers being imported.
- Overseas workers' remittances continued to grow and crossed the $13 billion mark in 2012. The growth rate in remittances over the past two years exceeded 45% partly due to Government efforts to divert remittances from informal to formal channels. These remittances have helped in containing the current account deficit.
- However, due to a much larger trade deficit in 2012, the current account deficit was estimated at 2% of GDP. The balance of payments position came under pressure due to declining financial inflows and substantial external debt repayments. As a result, foreign exchange reserves decreased and the domestic currency depreciated against the United States dollar.
- In order to realize its development potential, countries in South Asia in general will have to overcome a number of development challenges, including large concentrations of poverty and hunger, rising inequality, poor levels of human development, wide infrastructure gaps, lack of a diversified base for high value added products and exports, widespread food and energy insecurity and high risk of disasters.
- The subregion's economic, social and environmental priorities must be balanced in favour of eradicating extreme poverty and hunger. Today, South Asia remains home to the world's largest concentrations of people living in poverty and hunger, and people without access to basic sanitation and electricity. The subregion is also characterized by having the world's highest levels of child and maternal mortality. Progress on the health, nutrition and sanitation-related Millennium Development Goals and related targets has been stalled because of the large inequalities and disparities within populations that persist in the subregion.
- This subregion faces the dual challenge of raising productivity to ensure that incomes are rising and poverty is falling, and creating enough jobs for a growing working-age population, which is expanding by about 2% per annum. With almost 60% of the population under the age of 30, Governments of countries in South Asia have to take advantage of this demographic bulge. Otherwise, the consequence can be social unrest, conflict and insecurity.
- Countries in the subregion should maximize growth through productive job creation and appropriate structural change to reduce poverty, hunger and inequalities. Countries in the subregion should also provide good-quality education, health, sanitation and other infrastructure to make the most of the youth bulge. In addition, a minimum social protection floor should be established that meets the basic needs of vulnerable populations.
- South Asia faces growing energy demand, and a number of energy challenges — energy poverty, lack of available supplies, poor energy infrastructure and transport facilities and environmental externalities. The subregion's energy deficits are particularly detrimental in terms of growth and poverty alleviation as parts of the subregion faces regular and sustained power outages. Energy security, linked with energy availability, accessibility and affordability, is a paramount policy concern for countries in the subregion.
- Strengthened regional cooperation can help solve a number of the challenges facing South Asia and can be an important development strategy to ensure a sustainable future for the subregion. Greater regional integration not only increases intraregional trade, but also promotes efficiency-seeking investment in the subregion's supply chain and production networks. This, in turn, creates more and better jobs in addition to building productive capacity, particularly in the subregion's least developed countries.
- Regional cooperation can play a pivotal role in crafting solutions to shared vulnerabilities and helping ensure food and energy security, as well as reducing the subregion's vulnerability to natural disasters. Better connectivity, across the subregion and beyond, can help leverage the subregion's strategic location at the crossroads of Asia and the Pacific to re-emerge as the hub of East-West trade that it once was.