Pakistan will continue to face macroeconomic challenges despite steps to tighten fiscal and monetary policies to rein in high and unsustainable twin deficits, and in this backdrop, the country’s GDP is forecast to decelerate to 3.9 per cent in fiscal year 2019, says the Asian Development Bank (ADB) in a new report released on Wednesday.

The report forecasts that continued fiscal consolidation (reduction in underlying fiscal deficit) in FY-2020 will keep growth subdued at 3.6pc.

To meet its large financing needs, the government is discussing a macroeconomic stabilisation programme with the International Monetary Fund in addition to arranging financial assistance and oil credit facilities from bilateral sources.

The estimated GDP growth rate for fiscal 2017-18 had been revised downward by ADB from earlier 5.8pc to 5.2pc. Growth therefore slowed from 5.4pc a year earlier, with revisions indicating slowdowns in industry and services.

In its assessment on Pakistan’s economy in the ‘Asian Development Outlook’ for 2019, which is a comprehensive analysis of macroeconomic issues in developing Asia, the bank says: “Until macroeconomic imbalances are alleviated, the outlook is for slower growth, higher inflation, pressure on currency, and heavy external financing needed to maintain even a minimal cushion of foreign exchange reserves. Recurrent crises in the balance of payments require that firms become more export competitive.”

ADB says lower revenue collection and higher current expenditure pushed the budget deficit from the equivalent of 2.3pc of GDP in the first half of FY-2018 to 2.7pc a year later. This situation will make it a challenge for the government to achieve the reduction in the budget deficit it targets for fiscal 2018-19.

Noting that the supply side is already showing signs of a slowdown, agriculture is expected to underperform the 3.8pc growth target for fiscal year 2019 after water shortages struck as wet season crops were being sown.

Large-scale manufacturing reversed 6.6pc growth in the first half of FY-2018 to decline by 1.5pc in the same period of FY-2019 as domestic demand contracted and rising world prices crimped demand for raw materials.

The ADB report says that contraction hit all key categories, including a 0.2pc decline in textiles. A slowdown in agriculture and industry as domestic demand shrinks will keep growth in services subdued.

A government structural reform package announced in January this year is expected to support agriculture, facilitate new business openings, and continue to expand capacity in some industries to the forecast horizon.

Stabilisation policies and rising inflation are likely to contain growth in private consumption and investment, while public sector development spending has already slackened. With exchange rate flexibility and declining imports, net exports are expected to contribute to growth.

In the first eight months of the current fiscal, the government borrowed more from the central bank and less from commercial banks, freeing up liquidity with which commercial banks boosted credit to the private sector by 18.9pc over the same period of previous fiscal year. This sharply increased net domestic assets and nearly doubled broad money growth to 2.8pc.

The current account deficit, the report said, is expected to ease in current fiscal year but will remain high at the equivalent of 5pc of GDP because of the large trade deficit. It will narrow further to 3pc in fiscal 2019-20 with easing macroeconomic pressures on the external accounts.

Export growth plunged from double digits in the first seven months of the previous fiscal to 1.6pc in the same period of current fiscal year. It is expected, however, to strengthen in the remaining months of FY-2019 and further in 2019-2020 as the lagged impact of currency depreciation kicks in, along with the incentive package for export-oriented industries announced in January.

Imports fell by 0.8pc in the first seven months of current fiscal year from the same period of FY-2018, with imports other than oil 5.7pc lower because of slower domestic economic activity, currency depreciation, and an increase in import duties for nonessential items.

Remittances are expected to revive — having already risen by 10pc in the first seven months of current fiscal year over the same period of previous fiscal — as rupee depreciates further, economic activity in the Middle Eastern oil exporting countries that are major destinations for Pakistani migrants holds broadly steady, and the government takes measures to facilitate remittances through official channels, the report said.

The government’s diaspora bonds issued in January 2019, with terms of three and five years and an attractive return of over 6pc, aim to tap resources from overseas Pakistanis. Inflows that do not incur debt, such as foreign direct investment, are expected to be lower in current fiscal year as several CPEC energy projects are near completion.

Financing a high current account deficit in fiscal year 2018-19 will require substantial borrowing — as in the first seven months of the year — and use of much of the bilateral lending support announced in the early months of 2019 to finance the deficit in the balance of payments. Foreign exchange reserves, depleted to $8.1 billion in February 2019, will likely remain stressed at the end of current fiscal year.

Business and policy

The outlook report says Pakistan lags behind the South Asia regional average on most index indicators. Business competitiveness in Pakistan suffers under a challenging macroeconomic environment and adverse terms of trade, significantly eroding production and exports.

Pakistan’s exports, such as they are, remain largely primary products whose lack of sophistication and diversification condemn them to declining shares in world markets. Agricultural commodities, textiles and other manufactures with little value added comprise over 80pc of the exports.

The high cost of doing business is a key factor limiting firms’ ability to compete. Access to affordable capital is constrained by a shallow and underdeveloped capital market. Manufacturing firms face high corporate tax rates, taxes on dividends and retained earnings, cascading taxes levied on inter-corporate dividends, and a super tax levied on retained reserves.

The effective corporate tax rate of up to 49pc is significantly higher than taxes on international competitors. High custom duties on machinery imports raise the cost of investment, and high tariffs on raw materials and intermediate inputs erode the price competitiveness of both exporters and domestic industries facing stiff competition from imports. Similarly, high tariffs and undependable electric power add to production costs.

Pakistan’s cumbersome customs and clearance procedures and poor quality of logistics and infrastructure remain a constraint for the ability for just-in-time supply chain management. Investing in infrastructure and improving trade facilitation could boost participation in world markets, but the absence of industry-wide facilities to test and certify compliance would still leave many exporters disadvantaged.

Macroeconomic stability is needed to create an environment that inspires business confidence and is conducive to investment and trade. Facing twin deficits in fiscal and current accounts, the government has long been bedevilled by difficult policy choices that pit improved tax revenues against enhanced competitiveness.

Moreover, with anti-export bias in tax and exchange rate policies, and high government borrowing that crowds out private investment, firm competitiveness erodes, even though recent currency depreciation has supported exports, according to the ADB outlook.