The International Monetary Fund (IMF) has said that high inflation and tighter global financial conditions would continue to weigh on Pakistan's economy, pressuring its exchange rate and external stability.

The observations were part of the Fund's country report released on Thursday.

It said the average Consumer Price Index (CPI) inflation was expected to surge to 20 per cent in the current financial year while core inflation would also remain elevated due to higher energy prices and the rupee's decline.

The IMF said risks to Pakistan's economic outlook and implementation of the programme remained "high and tilted to the downside" because of what it termed a "very complex" domestic and external environment.

"Spillovers from the war in Ukraine through high food and fuel prices, and tighter global financial conditions will continue to weigh on Pakistan’s economy, pressuring the exchange rate and external stability. Policy slippages remain a risk, as evident in FY22, amplified by weak capacity and powerful vested interests, with the timing of elections uncertain given the complex political setting.

"Sociopolitical pressures are expected to remain high and could also weigh on policy and reform implementation, especially given the tenuous political coalition and their slim majority in Parliament," the IMF's report stated.

In addition, higher interest rates, a larger-than-expected growth slowdown, pressures on the exchange rate, renewed policy reversals, weaker medium-term growth, contingent liabilities related to state-owned enterprises and climate change were termed as substantial risks by the lender.

It cautioned that high food and fuel prices could trigger protests and instability, which could, in turn, jeopardise macro financial and external stability and debt sustainability.

Tight monetary policy

To combat inflation, the State Bank of Pakistan (SBP) should remain ready to continue the tightening cycle, the IMF said. The central bank had agreed to maintain a tight monetary policy and to take decisions regarding it in a forward-looking and data-driven way, it added.

According to the report, the SBP had also agreed to continue reducing the subsidies on refinancing facilities and phase out its involvement in the schemes for which it would prepare a transition plan by the end of this year.

"The authorities have advanced work on an initial plan in consultation with other stakeholders, and bringing the pricing of these schemes closer to market rates will limit their demand and thus facilitate their phasing out with the activity transferred to an appropriate Development Finance Institution.

"The SBP is also committed to managing banks' liquidity in line with its monetary policy objectives," the IMF report stated.

Exchange rate

The lender advised authorities to continue to allow the market to determine the exchange rate and avoid suppressing any trend movement.

A market-determined exchange rate would remain effective at absorbing shocks and was essential for reducing external imbalances and shoring up foreign reserves.

"Allowing a greater role for exchange rate flexibility to address external pressures will help safeguard and improve reserve buffers towards more prudent levels in line with programme targets," it noted.

Outlook

The IMF said real GDP growth, which has been above-trend for the last two years, was expected to reduce to 3.5 per cent in FY23 and gradually return to 5pc.

It stated that domestic demand would be notably reduced as energy prices were passed on to consumers and activity was dampened while purchasing power would be lost due to high inflation.

It forecast that inflation would fall significantly in the next fiscal year on the back of tighter fiscal and monetary policies. "The SBP is expected to reach its 5–7pc inflation target range gradually with medium-term inflation slowing to 6.5pc."

Meanwhile, the current account deficit would decline to 2.5pc of the GDP in FY23 compared to 4.7pc of GDP in the previous fiscal year, it stated. This would improve the reserve coverage of imports to 2.3 months from 1.7 months currently.

The Fund predicted that public debt would fall to 72pc of GDP at the end of FY23 because of a tighter fiscal policy and inflation eroding the value of rupee debt. "Supported by the planned fiscal adjustment and robust growth public debt is projected to follow a downward path towards 60pc of GDP by FY27, with external debt declining toward 25pc of GDP."