LAHORE: The Modeling Lab at the Lahore School of Economics has released its annual GDP growth estimates for Pakistan’s fiscal year 2025-26, projecting a modest growth rate of 2.4 percent based on macroeconomic variables observed during the first quarter from July to September. This figure represents no improvement from the previous fiscal year 2024-25, which also recorded a growth rate of 2.4 percent.
The report, titled State of the Pakistan Economy, Growth, and Inflation in Pakistan Financial Year 2025-2026 (Q1), was written by Dr Moazam Mahmood, Professor at the Faculty of Economics, Dr Azam Amjad Chaudhry, Professor and Dean of the Faculty of Economics, Amna Noor Fatima, Manager and Data Analyst at the Modeling Lab, Seemab Sajid, Data Analyst at the Modeling Lab, Anoosha Liaqat, Data Analyst at the Modeling Lab, and Syeda Khadijah Batool, Data Analyst at the Modeling Lab.
According to the report, Pakistan’s economic recovery has been progressing slowly following a near-stagnation three years ago. While fiscal year 2025-26 was expected to mark a return to near-trend growth levels, the latest estimates suggest otherwise. The primary factor contributing to this subdued growth outlook appears to be a significant deterioration in the country’s Current Account position.
The Current Account, which had shown signs of stabilisation in the previous fiscal year with a surplus of nearly two billion dollars, has reversed course dramatically. During the first quarter of the current fiscal year, the Current Account has slipped into a deficit of approximately 0.6 billion dollars. If this trend continues over the next three quarters, projections indicate an annual Current Account deficit of 2.4 billion dollars. This exogenous weakness in the Current Account has significantly dampened GDP growth prospects.
However, analysts caution that with only one quarter of data available, the 2.4 percent growth estimate should be considered a lower bound. If key macroeconomic aggregates, particularly the Current Account, improve over the remaining three quarters of the fiscal year, GDP growth could potentially reach 2.9 percent. This upper-bound estimate would align more closely with projections from other major institutions, including the Government of Pakistan’s lower-bound estimate of 3.3 percent, the International Monetary Fund’s forecast of 3.6 percent, the World Bank’s projection of 3.1 percent, and the Asian Development Bank’s estimate of 3.0 percent.
The model developed by the Lahore School’s Modeling Lab emphasizes the overwhelming impact of the Current Account on aggregate GDP growth by distinguishing between supply shocks and demand shocks. Supply shocks originate from endogenous sectoral growth patterns. Over the past three years, the largest supply shock has been the contraction in Large Scale Manufacturing. Nevertheless, during the first quarter of fiscal year 2025-26, this sector has finally shown positive growth.
The agricultural sector has similarly underperformed, growing below trend for the past two years. The Modeling Lab attributes this weakness partly to what it characterizes as a policy misstep by the Government of Pakistan, which removed long-established crop support prices. While previous State of the Economy reports from the Modeling Lab had highlighted this issue, they acknowledged that the policy has contributed to disinflationary pressures, albeit at the cost of growth in food and export staples. A potential reconsideration of support prices, combined with fortunately minimal flood damage, could lead to improved agricultural growth with a trend growth rate of 2.5 percent to 3.0 percent over fiscal year 2025-26.
Despite improvements in sectoral growth representing positive supply shocks during fiscal year 2025-26, these gains are being overshadowed by the larger impact of demand shocks. The Current Account’s reversal from a surplus in fiscal year 2024-25 to a deficit in the current year has created significant headwinds. While exports and remittance inflows have remained on trend, a surge in imports has driven the 0.6 billion dollar deficit in the first quarter of 2025-26. The economy’s fundamental vulnerability, its exogenous weakness, thus persists as it has historically.
The Modeling Lab estimates inflation for fiscal year 2025-26 at 7.1 percent, which aligns with the Government of Pakistan’s upper-end estimate ranging from 5 percent to 7.0 percent. The International Monetary Fund has projected a slightly lower inflation rate of 6.0 percent.
The model identifies exchange rate depreciation as the most significant contributor to the double-digit inflation that peaked at 38 percent three years ago. Following substantial depreciation from fiscal years 2021-22 through 2023-24, the exchange rate has stabilised over fiscal year 2024-25 and the current fiscal year 2025-26.
This stabilisation represents a notable policy achievement by the Government of Pakistan, which finally recognized the need to halt the damaging depreciation trend and implemented corrective measures through monetary policy and careful open-market operations conducted by the State Bank of Pakistan.
Energy prices represent the second major contributor to inflation, following the perennial fiscal deficit. Energy pricing has accounted for approximately 3.2 percent of inflation in fiscal year 2025-26. Notably, the Government of Pakistan’s 60 percent tax increase on energy has contributed more to rising energy prices than suppliers’ price increases, which rose by 40 percent.
Pakistan’s GDP growth remains extremely vulnerable to Current Account pressures. Export-led growth has long been promoted as the solution to this structural weakness. However, this growth strategy now faces additional challenges from a global trade environment disrupted by escalating tariff wars.
The fundamental question confronting policymakers is determining which growth path Pakistan should pursue given the uncertain international trade landscape. Research at the Lahore School indicates that Pakistan faces potential losses of approximately 0.6 billion dollars to its exports, with export volumes demonstrating extreme inelasticity to successive rounds of currency depreciation, particularly in the textile sector.
The Lahore School’s Modeling Lab has proposed an alternative solution based on its trade model for Pakistan. The research shows that GDP growth is constrained primarily by investment levels, which are in turn limited mainly by the import of investment goods. This finding suggests a policy approach that would liberalize the import of investment goods to stimulate investment and GDP growth. However, to maintain Current Account sustainability, such liberalization would need to be balanced by reducing imports of non-wage consumption goods. This approach would allow for necessary capital goods imports while curtailing less essential consumer imports, potentially creating a pathway toward more sustainable economic growth.
Copyright Business Recorder, 2025
