Economy slows as growth dips

While signs of macroeconomic recovery are emerging, Pakistan's economic growth decelerated during the first half of fiscal year 2024-25 (H1-FY25), as contraction in the industrial sector and a slowdown in agriculture weighed heavily on overall performance. Although the services sector witnessed a slight improvement, the overall real GDP growth moderated compared to the same period last year, reflecting persistent structural weaknesses in the economy, according to the latest review by the State Bank of Pakistan (SBP).

"Real GDP growth decelerated in H1-FY25, with contraction in industry and subdued growth in agriculture," said the SBP half-year report FY25 'The State of Pakistan's Economy.' The decline in industry is majorly contributed by construction, followed by mining and quarrying and large-scale manufacturing.

The slowdown was primarily led by a contraction in industry, compounded by the lagging effects of tight monetary policy, elevated energy costs, and fiscal consolidation measures, including reduced subsidies, restrained development spending, and new revenue mobilization efforts. Meanwhile, the agriculture sector also recorded a significant loss in momentum due to a broad-based decline in the production of Kharif crops. Uncertainty surrounding the announcement of support prices, lower crop prices in the previous season, and erratic weather conditions - intensified by climate change - contributed to reductions both in the area under cultivation and crop yields. The decline was further exacerbated by the reduced use of certified seeds and agricultural inputs.

Large Scale Manufacturing (LSM) witnessed a 1.9% decline during the July-February period of FY25, with the sharp fall in furniture production offsetting modest recoveries in major sectors such as textiles, automobiles, pharmaceuticals, and petroleum products. Construction and mining activities also contracted notably due to weaker exploration activity and soaring construction material costs.

However, the services sector offered a modest silver lining, supported by increased activity in government services, information and communication technology, and other private services. The combination of a softer industrial contraction and services sector growth translated into a marginal increase in employment and a nascent recovery in real wages after several years of decline.

Despite subdued growth, inflation trends offered some relief. Headline inflation fell sharply below the lower bound of the medium-term target range of 5–7%, reaching a multi-decade low of 0.7% in March 2025. This steep disinflation was driven by improved supplies of key food staples, adjustments in energy prices, subdued domestic demand, and favourable global commodity prices. Core inflation also eased to single digits beginning in October 2024.

In response to the easing inflationary environment, the SBP cut its policy rate by 1000 basis points between June 2024 and February 2025. The softening of global commodity prices, driven by improved supply chains and the easing of geopolitical tensions, further reinforced the disinflationary environment.

Pakistan's external account position improved markedly during the review period, aided mainly by strong worker remittances, somewhat rising IT exports and a steady momentum in goods exports. These gains financed a rise in imports and led to a surplus in the current account balance, while the SBP built its FX reserves through market purchases.

The foreign portfolio investment experienced net outflows, while Naya Pakistan Certificates attracted inflows on account of attractive returns. The increase in net foreign assets of the SBP was overshadowed by a significant contraction in net domestic assets, resulting in a contraction in broad money (M2) during H1-FY25, despite some increase in credit to the private sector.

Fiscal consolidation efforts remained a central theme, with the government achieving substantial budgetary retirements to scheduled banks and undertaking buyback auctions of treasury bills to manage rollover risks. While FBR tax collections improved, they still fell short of targets due to lower inflation, falling interest rates, and a stable exchange rate environment. The government's containment of non-interest expenditures through reduced development and subsidy spending contributed to maintaining fiscal discipline.

Nonetheless, the SBP warned that the burden of fiscal adjustment continues to fall heavily on development spending, which could compromise long-term growth potential unless broad structural reforms are initiated. The report highlighted the need to broaden the tax base, reduce reliance on regressive indirect taxes, and ease the tax burden on documented sectors such as salaried individuals and corporations.

A particularly concerning trend identified by the SBP is Pakistan's persistently low productivity growth.

"One of the prominent challenges long undermining the sustainability of growth is low and falling productivity that has adversely affected the country's economic competitiveness," said the SBP report. "This is particularly evidenced by Pakistan's lowest GDP per worker among the peer countries."

The report called for moving beyond reliance on temporary measures such as tax amnesties, subsidies, and foreign debt-funded growth, emphasising the need to address core structural weaknesses in areas such as education, healthcare, infrastructure, research and development, trade integration, and financial inclusion.