Management of the Pakistan Economy - Book 2025

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Editor’s Note

Chapter 01

State of the Pakistan Economy: Growth, Inflation, Welfare, and the Budget for the Fiscal Year 2025
Moazam Mahmood, Azam Chaudhry, Seemab Sajid, Amna Noor Fatima, and Sara Qasim

The Modeling Lab at the Lahore School of Economics estimated Pakistan’s gross domestic product (GDP) growth over the fiscal year (FY) 2025 (July 2024–June 2025) to be 2.44 percent. This represents a very weak recovery from the 1.7 percent GDP growth estimated for FY 2024 and the flatlining of GDP growth (0.05 percent) for FY 2023.Our estimate appears conservative compared to the World Bank’s higher-end estimate of 2.7 percent, the International Monetary Fund (IMF)’s estimate of 2.6 percent, and the Asian Development Bank’s estimate of 2.5 percent. The major productive sectors, manufacturing and agriculture, have weakened sectoral growth. Large-scale manufacturing contracted by 1.9 percent over the fiscal year after flatlining last year at 0.07 percent and experiencing a contraction of 2.9 percent the prior year. This paper explores the structural hypothesis that Pakistan’s GDP growth is constrained by external imbalances, leading to periodic crises and necessitating IMF bailouts. Inflation for FY 2025 is estimated at 8.37 percent, down from a peak of 33 percent in FY 2023, driven primarily by a stabilization of the exchange rate and a fiscal deficit of 6.0. The economy’s Achilles' heel is now considered to be the current account. Observed over three cycles (FY 2013–2024), GDP growth above five percent per annum inflated the current account deficit. This behavior is not well explained by exports, but by imports, which were observed to be very elastic with respect to GDP. A policy to ride this cyclical dragon is offered by the Lahore School’s Modeling Lab’s trade model for Pakistan, which shows GDP growth to be constrained primarily by investment. Investment, in turn, is constrained mainly by the import of investment goods. This finding argues for a policy to liberalize the import of investment goods to raise investment and GDP growth. However, the current account must be balanced by decreasing the import of non-wage consumption goods. Finally, high inflation and low GDP growth have resulted in an increase in poverty over time, estimated as a headcount in 2024 to be 30 percent of the population. As a start, ameliorating this headcount will require about five percent of tax revenues.

Chapter 02

Revisiting Balance-of-Payments-Constrained Growth in Pakistan
Azam Chaudhry, Gul Andaman, and Aymen Junaid

The balance-of-payments (BOP)-constrained growth rate is the maximum gross domestic product (GDP) growth rate above which unsustainable current account deficits emerge, forcing policymakers to implement contractionary measures that ultimately reduce GDP growth. We estimate Pakistan’s BOP-constrained annual growth rate to be 3.71 percent for the period 1996–2023, which is significantly lower than the estimate of 4.41 percent for the period 1980–2017. The BOP-constrained growth rate is most sensitive to changes in import income elasticity. If the import income elasticity value decreases from 1.47 to 1, the BOP-constrained growth rate increases from 3.71 percent to 5.45 percent. If remittance growth increases from 11.43 percent to 14 percent annually, the BOP-constrained growth rate increases from 3.71 percent to 4.09 percent. Similarly, if the real effective exchange rate (REER) grows at -1.5 percent annually instead of -0.83 percent, the BOP-constrained growth rate only increases to 4.02 percent. Finally, the impact of an increase in capital inflows from 13.18 percent to 15 percent annually only increases the BOP-constrained growth rate to 3.78 percent. Our analysis also reveals how Pakistan’s low total factor productivity (TFP) growth has weakened export competitiveness while increasing import dependence, exacerbating these BOP constraints. A coherent and holistic strategy of structural reforms is essential to boost the BOP-constrained growth rate.

Chapter 03

Monetary Policy in a Balance-of-Payments-Constrained Economy: Fiscal Dominance, External Vulnerability, and the Case for Caution in Pakistan
Naved Hamid and Murtaza Syed

Following a severe macroeconomic crisis in the fiscal year 2023, Pakistan has achieved notable stabilization, with inflation falling to historic lows and external buffers rebuilding. This has intensified the debate over the State Bank of Pakistan’s maintenance of a strongly positive real interest rate amidst modest economic growth. This paper argues that the current tight monetary stance is justified, given Pakistan’s history of boom-bust cycles driven by fiscal dominance and a consumption-led, import-intensive growth model. Pakistan’s growth is fundamentally constrained by its balance of payments, with a sustainable rate now estimated below four percent. Using recent data and historical patterns, we demonstrate that premature monetary loosening risks reigniting external pressures and exchange rate instability, thereby undermining the hard-won price stability. The primary conclusion is that monetary policy must prioritize price and financial stability over growth support until structural reforms significantly enhance productivity and export competitiveness.

Chapter 04

The Potential Impact of US Tariff Policies on Pakistani Exports to the US
Azam Chaudhry and Gul Andaman

This paper assesses the potential repercussions of US tariff policies on Pakistan's exports to the US. The imposition of a 19-percent tariff would result in an equivalent increase in costs for Pakistani exporters. Assuming this increase is passed entirely to end consumers and using long-run price elasticity estimates from Pakistan's export demand function, our analysis indicates that aggregate exports could decline by USD 0.40 billion or 7.6 percent in 2025 alone. Cumulative losses over five years could reach USD 2.11 billion. A sectoral analysis reveals that the textile and manufacturing sectors are particularly vulnerable, with textile exports potentially falling by USD 0.33 billion in 2025 and five-year cumulative losses of USD 1.74 billion. These findings underscore the need for a comprehensive mitigation strategy focused on enhancing competitiveness, diversifying exports, investing in renewable energy, and strengthening diplomatic and trade relations to cushion the economy against adverse tariff shocks.

Chapter 05

Navigating the Potential Impact of the Carbon Border Adjustment Mechanism on Pakistan’s Exports: Sectoral Implications and Future Challenges
Azam Chaudhry and Gul Andaman

This study assesses the potential impact of the European Union (EU)'s Carbon Border Adjustment Mechanism (CBAM) on Pakistan’s exports. Starting in 2026, CBAM’s definitive phase will initially target high-emission sectors, so Pakistan’s exports may not be immediately affected. However, the gradual expansion of CBAM’s coverage to textiles and agricultural products could significantly decrease demand for Pakistani goods as EU importers seek lower-carbon alternatives. Using historical export growth rates, this study projects Pakistan’s exports to the EU from 2024 to 2036 under scenarios with and without CBAM implementation in the agricultural, manufacturing, and industrial sectors. Sectoral emission intensities are estimated using greenhouse gas emissions data from Climate Watch and data from the Asian Development Bank’s input-output tables. By incorporating carbon pricing and Pakistan’s long-run price elasticity of demand for exports, we estimate that CBAM implementation in 2026 could result in a decline of USD 308 million in exports, reaching USD 479 million by 2036. This corresponds to reductions of 2.26 percent in manufacturing, 10.4 percent in agriculture, and 21.1 percent in industrial exports. Additionally, Pakistan’s export share to the EU, currently 29 percent, may decline by 2 percent in 2026. Our analysis suggests that the actual impact could be more severe if demand elasticity increases, carbon pricing rises, or if more countries implement similar mechanisms. To mitigate these risks, policymakers must establish a domestic carbon pricing system and transition toward environmentally sustainable production practices.

Chapter 06

Reconfiguring Growth Through Global Value Chains: Participation, Positioning, and Policy Lessons from Pakistan and Its Regional Competitors
Rabia Arif and Azam Chaudhry

This paper examines how a country’s integration into global value chains (GVCs) influences its economic growth. GVCs have transformed international trade by shifting the focus from final goods to fragmented production networks across countries. Using panel data from 2000 to 2022 and employing the generalized method of moments (GMM) approach, we separate traditional and GVC-led trade to evaluate their differential impacts on multiple macro indicators, including gross domestic product (GDP) per capita, total factor productivity, export intensity, and others. We distinguish between the dual dimensions of GVCs—participation and positioning, where participation constitutes forward/backward (F/B) trade ratios as critical determinants of long-term competitiveness. We find that forward linkages tend to hinder growth in low-income countries, while backward linkages enhance the export-to-GDP ratio. For middle-income nations like Pakistan, enhancing forward linkages is the most effective way to improve export performance and boost economic growth. We then assess Pakistan’s position within the GVC, as reflected in measures of upstreamness and downstreamness. Our comparison of Pakistan with other countries finds that it lags behind India, Bangladesh, and China, as it is characterized by strong downstream and weak forward linkages that limit value-added exports. A sectoral comparison, particularly between India's and Bangladesh's textile industries, further contextualizes Pakistan’s structural limitations. Policy strategies are proposed to deepen value addition and move Pakistan up the GVC ladder.

Chapter 07

Inflation Persistence and Expectations: Pakistan's Post-COVID-19 Inflationary Episode
Kalim Hyder, Sabina Khurram Jafri, and Omar Farooq Saqib

We posit that post-COVID-19 inflation persistence was at an elevated level due to high inflation expectations having morphed into a self-fulfilling prophecy amid cost shocks and policy uncertainty despite the slack in economic activity. We estimate a hybrid New Keynesian Phillips Curve for Pakistan and find a significant and positive pass-through of near-term inflation expectations on actual inflation. Specifying a threshold, the inflation expectations’ explanatory power is further established as it is found to be three times greater in high-inflation periods than in low-inflation ones. Another unique result for a developing country like Pakistan is that both forward- and backward-looking expectations carry nearly equal impact in baseline estimates. Thus, our findings underscore the need for an effective anchoring of inflation expectations in Pakistan.

Chapter 08

Sustainable Industrial Policies and Industrial Upgrading: The Southeast Asian Experience
Rajah Rasiah

The latecomer industrialization thesis has acted as a powerful instrument in promoting industrialization. However, there is insufficient research to explain why some economies that attempted to industrialize are facing premature deindustrialization while others have managed to not only catch up economically but also shape the technology frontier in a number of industries. This paper problematizes and assesses industrial policies and industrialization in Southeast Asia, focusing on the United Nations Sustainable Development Goals (SDGs). Geographic areas of interest include Timor-Leste; the market economies of Brunei Darussalam, Indonesia, Malaysia, the Philippines, Singapore, and Thailand; and the transition economies of Cambodia, the Lao People’s Democratic Republic (PDR), Myanmar, and Vietnam. Driven by an agile state, Singapore managed to become a developed economy through strong industrial upgrading. By 2024, Malaysia had launched four national industrial policies, while Indonesia, the Philippines, and Thailand introduced ad hoc strategies to support industrialization. Foreign transnational corporations have played a major role in stimulating manufacturing expansion in these economies. Meanwhile, Singapore’s deindustrialization has been accompanied by strong technological upgrading, while Indonesia, Malaysia, the Philippines, and Thailand have embarked on developing strategic high-technology industries, such as aerospace, to raise value added after years of premature deindustrialization. If governed effectively using a carrot-and-stick approach, it is possible for these countries to break out of the middleincome trap and reach developed status. Brunei Darussalam has shown promise in its efforts since 2018 to stimulate petroleum-related downstream processing. Vietnam has industrialized the most among the transition economies; its gross domestic product per capita has grown rapidly to join Indonesia and the Philippines in lower middle-income status. While Cambodia, Lao PDR, and Myanmar have industrialized considerably, they remain at a crossroads, with little effort to build the science, technology, and innovation infrastructure required to stimulate industrial upgrading. Timor-Leste is still pegged in primary processing activities.

Chapter 09

Mitigating Air Pollution in Punjab’s Transport Sector: Constraints and Opportunities
Natasha Moeen, Mehreen Khan, and Theresa Thompson Chaudhry

Pakistan ranks among the world’s most polluted countries, with transport emissions being a major contributor to deteriorating air quality. In Punjab, rising smog poses serious environmental and public health risks, with Lahore’s transport sector contributing nearly 83 percent of total emissions, followed by Multan. The government of Pakistan introduced the Clean Air Policy (2023) to tackle this, outlining cross-sectoral interventions for various stakeholders. This study explores barriers and opportunities for mitigating transportrelated air pollution through 25 unstructured interviews. Findings reveal key barriers, which include weak interdepartmental coordination in phasing out old vehicles, high import and electricity tariffs that limit electric vehicle (EV) adoption, inadequate EV charging infrastructure, and poor fuel quality. Opportunities include subsidized EVs, improved public transport with feeder networks, and enhanced local capacity to provide Euro V fuel. Policymakers must understand these factors to design targeted interventions, improve air quality, and protect public health.

Chapter 10

Pricing Energy and Retiring Circular Debt
Rabia Ikram, Moazam Mahmood, and Muzzna Maqsood

This paper examines the structural drivers of circular debt in Pakistan’s power sector, focusing on energy pricing reforms and capacity payment obligations under privatized electricity generation contracts. Although the efficiency hypothesis implies that private sector involvement enhances cost recovery and decreases fiscal burdens, Pakistan’s experience indicates the existence of chronic financial imbalances. Based on data for the period of 2006–2024, this paper examines circular debt accumulation trends, electricity tariffs, and the payables composition of public and private generation entities. The results indicate that, even with significant tariff rates, circular debt has been increasing. More specifically, the increasing portion of capacity purchase payments within total power purchase costs is closely linked to debt accumulation. This suggests that circular debt is not solely the result of tariff under-recovery but reflects deeper structural rigidities embedded in fixed contractual obligations and institutional inefficiencies. This paper posits that to implement sustainable reform, it is necessary to address capacity payment designs, subsidy management, and pricing changes to regain financial stability and ensure competitiveness.

Chapter 11

Governance Factors and the Role of Independent Power Producers in the Power Sector’s Performance Outcomes: International Evidence
Jamshed Y. Uppal

Independent power producers (IPPs) are major sources of power generation around the world. Countries faced with severe energy shortages and limited public resources have turned to private investors to ameliorate the situation. However, IPPs in Pakistan have suffered from corruption allegations and doubts over contract fairness, operating performance, and their ability to decrease energy disparities. There is a need for broader reforms, especially a regulatory and governance environment that is conducive to leveraging private investment to bolster energy infrastructure. This paper’s key objective is to explore the links between a country’s governance and regulatory environment and the performance of IPPs in terms of access, price, quality, and technical and financial performance. The analysis is based on data from 50 countries over the period 2017–2019 and assesses six dimensions of governance. The initial results confirm the hypothesis that regulatory and governance factors significantly affect IPP performance. The results underscore the importance of improving government effectiveness, the rule of law, and regulatory quality, and controlling corruption so that IPPs can better fulfill their potential.

Chapter 12

Saving, Investment, and Outflows in Pakistan
Moazam Mahmood, Shamyla Chaudry, and Muzzna Maqsood

This paper follows neoclassical theory, in which the current account (CA) reflects domestic imbalance, the difference between investment (I) and saving (S). In estimating the equation for the fiscal year 2022, we obtained an investment-saving gap (I - S) of two percent of income, whereas the CA was four percent of income. Therefore, when equating (I - S) to the CA, the neoclassical theory stands in jeopardy. However, we obtained a better fit when we reconsidered S by re-estimating it to account for outflows (KO). S should comprise all domestic earnings that are not consumed, while KO consists of income earned domestically that crosses borders and is transferred abroad. Therefore, KO is lost to domestic saving (Sdom) and I. Ergo, KO should be added to Sdom. We estimated KO for the fiscal year 2022 at 2.3 percent of income using the Mahmood & Chaudry (2020) equation. Therefore, our equation changed to (I - S) + KO = CA after incorporating KO to support the theory. Estimating the equation gave 1.96 percent + 2.3 percent, which is approximately equal to 4 percent. This equals the CA of four percent. Therefore, we have reestablished the neoclassical investment-saving identity.