The inevitable has happened. As Pakistan’s and India’s newest conflict escalated, the economy was left to wait and watch as military confrontation between the two nuclear-armed neighbours slowly became a reality.

Despite these challenges, Pakistan’s economic managers remain optimistic — a difficult feat — that the wheels of the economy will keep turning in the right direction.

The International Monetary Fund projects an economic growth of 2.6 per cent for this fiscal year. However, there are no signs of accelerated growth, particularly with agriculture suffering from water shortages, industry facing high energy costs and interest rates, and the services sector mirroring the sluggishness of agriculture and industry.

With the fiscal budget around the corner and the Pakistan-India conflict, the space for cutting current expenses is severely limited

War-related disruptions in interprovincial transport and a challenging environment for retail and wholesale markets could further hamper growth in the services sector. Temporary tightening of regulations in the financial sector, such as stricter monitoring of foreign exchange outflows, could compound these challenges.

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In the first half of this fiscal year (July–December 2024), Pakistan’s economy grew by 1.5pc. The State Bank of Pakistan (SBP) maintains its growth projection at 2.5pc to 3.5pc while acknowledging risks stemming from global uncertainties and potential weather challenges for the upcoming Kharif season.

Although the SBP recently reduced the interest rate by 100 basis points to 11pc, industrialists argue that this modest easing is insufficient for meaningful industrial recovery. April’s inflation rate was just 0.3pc year-on-year — the lowest in six decades. Despite this historic low, the central bank remains cautious, targeting full fiscal year inflation within the 5-7pc range. From July 2024 to April 2025, annualised national consumer inflation averaged 4.73pc.

A growing concern is the imposition of emergency operation surcharges on Pakistan’s cargo by international shipping lines following Indian military aggression and Pakistan’s retaliatory measures, according to a recent Dawn report.

The Ministry of Finance indicates development spending for the next fiscal year will be reduced to Rs921bn, meaning about 200 ongoing projects may have to be abandoned

Freight and container costs are climbing as India has not only banned imports from Pakistan but also prohibited the transit of cargo originating from it. These rising costs threaten Pakistan’s goods trade, which is already struggling to balance imports and exports.

Higher shipping costs are likely to impact exports, making it even more difficult to manage the trade deficit. During 10MFY25, Pakistan’s trade deficit stood at $19.62 billion (less than $2bn per month), according to the Pakistan Bureau of Statistics.

This average monthly trade deficit is much lower than the average monthly home remittances of over $3bn, with $28bn received in 9MFY25. For now, this cushion is strong enough to offset the trade deficit.

However, problems may arise in the next fiscal year if military tensions disrupt remittance flows or if the trade deficit continues to widen. In April, the trade deficit surged to $3.38bn from $2.18bn in March, driven by larger imports of industrial raw materials and finished consumer goods.

Pakistan’s economic managers now face the challenge of balancing the need to contain the trade deficit with the revival of industrial production through essential imports. If the military confrontation is short-lived, this balance will be easier to achieve. If not, it could become a severe economic strain.

Managing economic stability is always a priority for the government, but the current hybrid regime cannot afford any missteps — especially with the next fiscal year budget approaching.

The federal budget is due on June 2, and the government is already grappling with a shortage of funds for development projects. Planning Minister Ahsan Iqbal recently revealed that the Ministry of Finance has indicated development spending for the next fiscal year could be Rs921bn — far below his ministry’s demand of Rs2.9 trillion. This shortfall means that nearly 200 ongoing development projects may have to be abandoned.

In the first ten months of the current fiscal year, actual development spending totalled Rs449bn compared to an initial budget allocation of Rs1.1tr for the full year. This disappointingly low spending resulted from the government’s inability to control current expenses and meet revenue collection targets.

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Reduced development spending not only impacts millions of Pakistani citizens but also hampers Pakistan’s potential economic growth. For many years, cutting development expenses has been an expedient tool for successive governments to offset revenue shortfalls. However, no government seems to recognise that slashing development budgets — particularly in critical areas like roads and highways, water and power, health, and education — compromises the nation’s long-term economic prospects.

With the ongoing Pakistan-India escalation, the space for cutting current expenses — of which defence spending is a part — is severely limited.

This heightens the need for the government to accelerate the privatisation of loss-making state-owned enterprises and enforce tax reforms aimed at broadening the tax base and preventing revenue leakages. Whether the government possesses the political will to execute these reforms remains to be seen.

Published in Dawn, The Business and Finance Weekly, May 12th, 2025