With a level playing field, industrial units—both for exports and import substitution—will begin to chip away at the trade deficit, external debt, and the risk of credit defaults. Photo: REUTERS
LAHORE:
The fragile economic recovery of Pakistan is once again under pressure as the current account deficit widens, undermining growth expectations for the ongoing fiscal year.
A new analysis of the Lahore School of Economics (LSE) shows that GDP growth for FY 2025-26 is projected at just 2.4%, the same level as recorded in the previous year, after the current account slipped back into deficit during the first quarter.
The report, prepared by the LSE’s Modeling Lab and Innovation & Technology Centre, warns that the economy’s Achilles heel remains its vulnerability to external shocks. It notes that while Pakistan entered FY26 with optimism due to a current account surplus of nearly $2 billion in the previous fiscal year, the trend reversed quickly.
During July-September 2025, the current account posted a deficit of $0.6 billion, which, if extended across the year, could widen to $2.4 billion. According to the authors, including economists Dr Moazam Mahmood and Dr Azam Amjad Chaudhry, this reversal has significantly dampened hopes for acceleration in growth. Their model shows that the weakening external position is the biggest factor dragging GDP growth down to 2.4%, despite improvements in domestic sectors such as manufacturing and agriculture.
The report notes that GDP growth could still improve during the remainder of the year, but only marginally. If imports cool off and other macro indicators strengthen, the economy may reach an upper-bound growth rate of 2.9% in FY26. Even this figure would remain below projections of international institutions, with the government targeting 3.3%, the IMF estimating 3.6% and the World Bank predicting 3.1%.
On the supply side, the study highlights slight improvements in key domestic sectors. Large-scale manufacturing, which had contracted for the past three years, finally returned to positive territory with 0.5% growth in the first quarter. The agriculture sector is also expected to recover to its trend range of 2.5-3%, supported by low flood damage and the possible reconsideration of long-standing crop support prices, which were removed in recent years. However, the LSE team concludes that these internal gains are overshadowed by external pressures. A surge in imports, despite stable exports and steady remittance flows, has tilted the current account back into deficit. This demand-side shock, the report says, is now the strongest downward force on the overall economy.
Alongside growth concerns, the study also provides a fresh estimate for inflation. It projects consumer inflation at 7.1% for FY26, which is broadly aligned with the government’s expectation of 5% to 7% but slightly higher than the IMF’s forecast of 6%.
The researchers attribute the bulk of earlier double-digit inflation, peaking at 38% three years ago, to steep exchange rate depreciation. They note that the exchange rate has finally stabilised over the past two fiscal years due to tighter monetary policy and improved market management by the State Bank.
Energy prices remain the second major driver of inflation. The analysis shows that energy-related costs contributed around 4% to inflation last year and will continue to add approximately 3.2% this year. Interestingly, the study finds that 60% of the rise in energy prices comes from government taxes, while only 40% stems from supplier price adjustments.
The researchers argue that Pakistan needs a clearer and more balanced strategy to handle its external vulnerabilities. While export-led growth has long been proposed as the ideal path, the report warns that global trade tensions and tariff barriers, especially from the US and EU, are limiting Pakistan’s export prospects. It refers to recent research estimating losses of $0.6 billion for Pakistani exports in the US market due to tariff changes.
The LSE Modeling Lab suggests that the government may need to liberalise imports of investment goods to support long-term growth, while cutting imports of non-essential consumption items to keep the current account sustainable. The authors say this long-standing structural dilemma, balancing stability with growth, will remain at the centre of macroeconomic policy debate.
