Update on the economy and the prospects

Pakistan has been efficiently deploying localized lockdowns to restrict the spread of COVID-19 since imposing a countrywide lockdown in response to the first COVID-19 wave, allowing economic activity to mostly continue. The expansion of the national cash transfer program, a mass vaccination drive, accommodating macroeconomic policies, and banking sector support all served to alleviate the pandemic's negative impacts. As a result, after shrinking by 1.0 percent in FY20, real GDP growth at constant factor 2015-16 prices rebounded to 5.6 percent in FY21.

Nonetheless, the economy's long-standing structural difficulties and poor productivity growth threaten long-term recovery. Strong aggregate demand pressures, owing in part to previously accommodative fiscal and monetary policies, combined with the continuation of less accommodative fiscal and monetary policies combined with the country's prolonged unfavorable external climate for exports, the country has a record-high trade imbalance, putting pressure on the rupee and the government's limited foreign reserves.

Indicators have mainly shown favorable economic momentum from July to December 2021 (H1 FY22). Private consumption is expected to have improved as community mobility improves and official remittance inflows remain strong. Similarly, with high growth in machinery imports and government development expenditure, investment is likely to have increased. With the purchase of vaccines, government consumption increased significantly. Agricultural output, primarily rice, and sugarcane, increased as a result of improved meteorological conditions. Similarly, growth in large-scale manufacturing increased to 7.5 percent y-o-y in H1 FY22, up from 1.5 percent in H1 FY21. Business and consumer confidence, on the other hand, has been declining since June 2021, because of fears about rising inflation and interest rates.

Headline inflation increased to 9.8% y-o-y in H1 FY22, up from 8.6% in H1 FY21, thanks to higher global commodity prices and a weaker currency rate. Similarly, since September 2021, core inflation has been rising. As a result, the State Bank of Pakistan has been gradually unwinding its expansionary monetary policy since September 2021, boosting the policy rate by 275 basis points (bps) and the cash reserve requirement for banks by 100 bps.

The current account deficit (CAD) increased to US$9.0 billion in H1 FY22, up from US$1.2 billion in H1 FY21, as imports increased by 54.4 percent, more than twice the 27.3 percent increase in exports. Remittances grew by double digits in H1 FY22, helping to finance the country's record-high trade deficit. The financial account saw net inflows of US$10.1 billion, fueled by the new IMF SDR allocation, Saudi Arabian short-term government deposits, and a July 2021 Eurobond issuance. The government received US$2.1 billion in January-February through international Sukuk and the IMF Extended Fund Facility (EFF). Despite these inflows, by March 25, 2022, foreign exchange reserves had decreased to US$13.5 billion, equivalent to 2.0 months of imports of goods and services.

Poverty measured at the lower-middle-income class poverty level of $3.20 PPP 2011 per day is anticipated to have decreased from 37.0 percent in FY20 to 34.0 percent in FY21, thanks to the economic recovery and improving labor market conditions. Inflationary pressures on food and energy are likely to erode households' actual purchasing power, disproportionately hurting poor and vulnerable households that spend a bigger amount of their budget on these commodities. In February 2022, the government budget deficit (including grants) is expected to grow marginally to 6.2 percent of GDP in FY22, before steadily narrowing over time as revenue mobilization initiatives, such as GST harmonization and personal income tax reform, take effect. Public debt as a percentage of GDP is expected to remain high in the short term, but progressively drop in the medium term. The projection assumes that the IMF-EFF program stays on track.

The macroeconomic risks are heavily skewed to the negative. They include a faster-than-expected tightening of global financial conditions, higher global energy prices, and the possibility of COVID-19-related mobility restrictions being reinstated. Domestically, political squabbles and policy reversals can result in long-term macroeconomic imbalances.ment responded by introducing a targeted food subsidy program (Ehsaas Rashan Riyat).