Agriculture, Industry Drive Robust Growth in Pakistan Amid Looming Challenges — ADB

News Release |

ISLAMABAD, PAKISTAN (26 September 2018) — Pakistan’s economy accelerated to 5.8%, the highest in 13 years, in Fiscal Year (FY) 2018 ending on 30 June 2018. The robust growth is credited to an uptick in industry, better agricultural crops, and an expanding services sector. Inflation remained moderate. However, with the new government considering policy options to implement its economic and social agenda, twin deficits widened by a rising import bill and higher spending continue to pose a challenge, according to the Asian Development Outlook (ADO) Update 2018.

The update of the Asian Development Bank’s (ADB) flagship annual economic publication noted that agriculture grew to 3.8%, nearly double that of a year earlier, boosted by favorable weather and a marked increase in food crops, cotton, and livestock. Industry growth climbed to 5.8% from 5.4%, underpinned by improvements in wholesale and retail businesses, faster expansion in manufacturing and mining, and sharp growth of over 9% in construction.

On the demand side, private consumption in FY2018 slowed slightly from a year earlier to 6.3% but, with an 81.1% share of gross domestic product (GDP), remained the largest contributor to growth. Public sector fixed investment grew by 17.1% on top of 27.5% expansion in FY2017, reflecting higher spending on energy and infrastructure in connection with the China–Pakistan Economic Corridor (CPEC). This growth was, however, from a low base as public investment still provides only 5.4% of GDP. Growth in private investment fell markedly to only 1.1% in FY2018 despite improved security and energy supply. The drop reflected a cautious business environment in light of the deteriorating balance of payments position and in anticipation of the national elections in July 2018.

In FY2018, responding to continued strong import demand and a large decline in net foreign assets, the State Bank of Pakistan allowed greater market determination of Pakistan rupee–US dollar exchange from December 2017 and raised the policy rate by a cumulative 75 basis points (bps) to 6.5% in two steps by the end of FY2018, first in January and then in May. The rupee depreciated by 15.3% against the US dollar in the 8 months to July 2018, and the average rate on new lending to the private sector increased by only 41 basis points to 7.83% by June.

The current account deficit in FY2018 swelled to $18 billion, or 5.8% of GDP, significantly up from 4.1% in FY2017. Exports revived to grow by 12.6% to $25 billion with increases in such traditional standbys as textiles, chemicals, leather, and food, but imports increased by 14.7% to $56 billion, partly spurred by purchases of machinery and transport equipment for the CPEC and other investments but also of intermediate goods for agriculture and the textile and metal industries, and of petroleum, which has accounted for just over a third of the increase in imports as current account deficit escalated over the past 2 years. The deficit in services and primary income also increased substantially by 19.0% to $11.2 billion. Workers remittances grew only by 1.4% but remained large at $19.6 billion.

Moving forward, the report says the newly elected government should address the large budget and current account deficits, rising debt obligations, and falling foreign exchange reserves. This requires mobilizing substantial external financing to buy time for orderly reform to reduce the large external and domestic imbalances. Such resources can be acquired from bilateral and multilateral sources, the diaspora, or international capital markets. The key challenges are to adopt the right reforms and achieve good outcomes to sustain public support, the report noted.

“Pakistan’s economy has time and again shown resilience and the capacity to bounce back. Although formidable development challenges remain, we expect the stability fostered by the smooth political transition and the new government’s strong commitment to focus on pockets of vulnerabilities and implement pro-job and socioeconomic development policies that will stimulate robust, sustainable growth in the years ahead,” said ADB Country Director for Pakistan Ms. Xiaohong Yang.

“ADB will work closely with the government and the private sector to improve Pakistan’s basic public services, infrastructure, food and energy security, and attract investment and trade to create jobs and improve the quality of life of the country’s citizens.”

The ADO 2018 Update forecasts that if the government is successful in obtaining finance, Pakistan will have reasonable growth prospects for FY2019 on the strength of an improved security and energy supply, continued investment in the CPEC and other initiatives, and recognition of the need to rein in deficits. Challenges to maintaining the growth momentum are tighter monetary and fiscal policies to contain domestic demand, currency depreciation, and tension in the global trade environment. On balance, the update projects GDP growth in FY2019 at 4.8%, down by 1.0 percentage point from last year.

On the supply side, water shortages in some areas are likely to keep agricultural production below target in FY2019. Growth in manufacturing and services will likely be affected by fiscal and monetary tightening. On top of dealing with macroeconomic imbalances, the new government faces long-delayed decisions on raising tariffs to contain rapidly rising and potentially disruptive intercompany arrears in the energy sector—so called “circular debt” that exceeds PRs1.4 trillion, or 5% of GDP.

Average annual inflation is projected to reach 6.5% in FY2019 because of currency depreciation and elevated international oil prices. Inflation accelerated sharply for both food and other purchases in the first two months of FY2019, to 5.8% from 3.2% a year earlier. The SBP increased the policy rate by 100 bps to reach to 7.5% in July 2018 in an effort to contain the inflation pressure and is likely to continue further as part of its monetary tightening.

“The new government needs to move swiftly to put in place its macroeconomic policies including fiscal, monetary, tax, and trade reform policies to promote financial stability and growth. Pakistan needs to institute mechanisms to increase competitiveness, attract private sector investments, and strengthen the ease of doing business as well as Pakistan’s position in the global value chain,” said Ms. Yang.

ADB is committed to achieving a prosperous, inclusive, resilient, and sustainable Asia and the Pacific, while sustaining its efforts to eradicate extreme poverty. Established in 1966, it is owned by 67 members—48 from the region. In 2017, ADB operations totaled $32.2 billion, including $11.9 billion in cofinancing.