Pakistan

Growth undermined by inflation and insecurity

The economy shrank slightly in 2023, penalised by galloping inflation triggered by extensive flooding in the Indus Valley at the end of 2022 that destroyed much of the region’s farmland, and the war in Ukraine, which pushed up food prices. In addition, accelerated depreciation of the rupee since January 2023 (-20%) and increases in gas prices and taxes demanded by the IMF as part of the SBA programme have also fuelled inflation. The latter will slow in 2024 thanks to the fall in global food prices and the transmission, albeit imperfect, of the restrictive monetary policy; the Central Bank raised its rate to 22% in July 2023. However, inflation will remain high and will continue to weigh on private consumption (80% of GDP), while public spending will continue to be limited by narrow budgetary headroom. Private investment will continue to be hampered by the high interest rates charged by commercial banks and by (geo)political instability which includes uncertainty over the formation of a government, the army’s influence and terrorist attacks. Internal and external tensions are delaying cross-border infrastructure projects. The construction of the China-Pakistan Economic Corridor (CPEC), launched in 2013, could strengthen the country's regional and trade integration by linking Kashgar in China's Xinjiang to the Pakistani port of Gwadar on the Indian Ocean. In July 2023, China granted a two-year extension on a related USD 2.4 billion loan. However, the project is jeopardised by debt and security risks, as the port is located in Baluchistan and close to Iran, a region affected by attacks from autonomist groups. This situation, coupled with US sanctions against Iran, is also delaying the construction of a binational gas pipeline. The rise to power of the Taliban in Afghanistan in 2021 has delayed the completion of the Central Asia-South Asia power line (CASA1000) between Tajikistan, Kyrgyzstan, and Pakistan, as well as the TAPI (Turkmenistan, Afghanistan, Pakistan, India) gas pipeline designed to transport Turkmen gas to Pakistan and India. On the supply side, growth will be underpinned by a recovery in agriculture (23% of GDP) and textiles, which depend on local cotton production, via base effects, these sectors having been undermined by last year's floods. However, growth in services (wholesale and retail trade), which account for 58% of GDP, will be modest and penalised by weak domestic demand.

Tensions over debt and public finances

In July 2023, the country narrowly avoided default thanks to an IMF rescue plan – the 23rd in 60 years – in the shape of a USD 3 billion Stand-By Arrangement (SBA), of which USD 1.9 billion has already been disbursed. The agreement made it possible to release funds from Saudi Arabia (USD 2 billion) and the United Arab Emirates (USD 1 billion). However, with a USD 1 billion eurobond due to mature in mid-April 2024 and the SBA due to expire at the beginning of the same month, the new government will need to quickly negotiate a new agreement with the IMF in order to obtain new funds, which are essential for debt sustainability. It will therefore try to maintain good relations with the United States, given its influence over the IMF, as well as with China and the Gulf States, the country's main bilateral creditors. Foreign debt accounts for 40% of total public debt. Foreign creditors are mainly multilateral and bilateral (85%), with Chinese claims (official and commercial banks) accounting for 28.6% of external debt. Domestic debt, which represents 60% of total public debt, is almost exclusively denominated in Pakistani rupees and accounts for 85% of total interest.

In 2024, the country's finances will remain heavily restricted by low revenues (12.5% of GDP) due to informality, tax exemptions, tax evasion and corruption. They are burdened by debt servicing (23% of GDP, including amortisation and interest), with interest payments alone accounting for more than 60% of public revenue. The large military expenditure of this nuclear-armed country will absorb 14% of revenues. However, in the 2023-24 fiscal year, the public deficit will fall sharply thanks to the austerity reforms demanded by the IMF. The country will continue to implement the elimination of energy subsidies and the floating of the exchange rate, and will have to reform the over-indebted public sector (especially state-owned enterprises) and strengthen governance. These measures should enable Pakistan to negotiate a new agreement with the Fund, at a time when its public gross financing needs exceed 20% of GDP.

A fragile external account

Pakistan's trade balance is structurally in deficit (equating to -10.5% of GDP in 2022) due to the country’s heavy dependence on imports – mainly energy and food – the bill for which far exceeds export earnings. The latter are dominated (60% of the total) by textile products (garments and linen) made from locally produced cotton (the world's fifth-largest producer), mainly sent to the US and Western Europe. The vulnerability of cotton harvests to weather conditions (monsoon), the low added value of garments and the narrowness of the manufacturing sector (13% of GDP) weaken the country's external trade. This heavy dependence on imports and the insignificance of foreign investment (0.45% of GDP) are weighing on foreign exchange reserves, which fell to three weeks' worth of imports at the start of 2023. These reserves were gradually replenished during the year thanks to a reduction in imports, the resilience of expatriate remittances, and bilateral and multilateral financing. In 2024, the country will continue to benefit from international aid to finance its very small current account deficit. This will increase as import restrictions are gradually lifted.

Fragile coalition of traditional parties in a tense (geo)political climate

No party managed to win an absolute majority in the contested legislative elections held on 8 February 2024. A total of 128.5 million voters went to the polls, with a turnout of 47%. Independent candidates came out on top (101 seats), 93 of which were affiliated to the Pakistan Tehreek-e-Insaf or Pakistan Movement for Justice (PTI) but were not authorised to run under the party's colours. Party leader, former Prime Minister Imran Khan, has been imprisoned since August 2023 on multiple charges. In second place, the Pakistan Muslim League-Nawaz (PML-N), led by Nawaz Sharif, won 75 seats, followed by the Pakistan People's Party (PPP) with 54 seats. Although the PTI came out on top, it was unable to take power. The PML-N and the PPP struggled to join forces with five other parties to obtain an absolute majority in the National Assembly (169 seats out of 336). They will also benefit from a proportional share of the 70 seats reserved for women and non-Muslim minorities. These two traditional parties have alternated in power since the simultaneous independence of Pakistan and India in 1947. Shehbaz Sharif, appointed by his brother, is expected to head the government following the 29 February parliamentary vote. The new government will run the country under the army’s supervision. Since 1947, the army has overthrown the government three times and directly ruled the country for a total of more than three decades. The army's Chief of Staff, Asim Munir, will retain his influence on defence and foreign affairs, invoking domestic insecurity and dangerous bordering countries.

The electoral process was marked by irregularities and significant violence, which carried on after the elections. The violence took place against a difficult socio-economic backdrop, in which rapid population growth (+2% per year) outstrips economic growth and maintains poverty (40% of the population). The squeeze on imports, while contributing to rising prices, has led to widespread shortages of food and fuel in 2023. Deficient health and education systems, high unemployment (8.5% in the formal economy alone) and informality (80% of jobs without social protection) exacerbate precariousness in a context of budgetary discipline and widespread corruption. The situation is fuelling Islamist terrorism and prompted over 860,000 Pakistanis to leave the country in 2023 in search of work. In addition, tensions with neighbouring countries, notably India (ceasefire in Kashmir since 2021), Afghanistan (disputed border) and Iran (divided Baloch population) are fuelling instability. Tehran and Islamabad accuse each other of not doing enough to deal with the autonomous Balochi groups that carry out attacks in both countries, denouncing lagging development and lack of control over their mineral resources.

Last updatedFebruary 2024