By Farooq Awan

Pakistan’s economy regained momentum during the first half of fiscal year 2025-26 as industrial activity rebounded sharply, inflation eased significantly, and macroeconomic stability improved despite flood-related disruptions and rising global uncertainty, according to the State Bank of Pakistan’s Half Year Report 2025-26.

The central bank said real GDP expanded by 3.8 percent in H1-FY26, almost double the 1.9 percent growth recorded in the same period last year, reflecting broad-based improvement across industry, services and agriculture. The recovery was supported by lower inflation, easing borrowing costs, fiscal consolidation and relative stability in the external account.

The report described the improvement as a sign that Pakistan’s stabilisation policies were beginning to produce tangible economic gains after years of severe macroeconomic stress marked by high inflation, exchange-rate volatility and weak industrial output.

Industry emerged as the primary growth driver during the review period, recording 8.1 percent growth compared with just 0.5 percent a year earlier. Large-scale manufacturing (LSM), which had remained under pressure for three consecutive years, posted a recovery of 4.8 percent in H1-FY26.

The central bank attributed the rebound mainly to improved domestic demand, declining financing costs and easing input prices. Automobile production, textile manufacturing and petroleum products were among the major contributors to industrial expansion.

The report noted that stable exchange rates and moderation in inflation had helped restore business confidence, encouraging firms to increase production and investment activity. Construction-related sectors also improved due to higher public development spending and government-backed housing incentives.

Agriculture, while facing climate-related challenges, also contributed positively to overall growth. The sector expanded by 2.2 percent during H1-FY26, supported primarily by livestock growth, which offset flood-related damage to some major crops. Rice and sugarcane output performed better than initially feared after coordinated flood-response measures helped contain losses in affected areas.

The services sector grew 3.1 percent in H1 of FY-26, benefiting from stronger activity in wholesale and retail trade, transportation and public administration. The improved performance of commodity-producing sectors generated positive spillovers into services, reinforcing the broader recovery trend.

One of the most notable developments during the period was the sharp moderation in inflation. Average national CPI inflation fell to 5.2 percent in H1-FY26 from 7.2 percent in the same period last year, moving close to the lower bound of the central bank’s medium-term target range.

The easing in inflation was driven largely by lower energy prices, exchange-rate stability and softer global commodity prices. Electricity tariff adjustments and reforms in the power sector also contributed to reduced energy inflation.

However, the report warned that food inflation remained elevated due to lower wheat production, flood-related supply disruptions and inefficiencies in agricultural commodity markets. Core inflation also remained relatively sticky because of persistent pressures from rents, education costs and wage adjustments.

The central bank maintained a cautious monetary policy stance despite the inflation slowdown. The policy rate was held steady during July-October 2025 before being reduced by 50 basis points in December 2025, bringing the cumulative reduction since June 2024 to 1,150 basis points.

Fiscal performance also showed significant improvement. Pakistan posted a fiscal surplus in H1-FY26 for the first time since FY02, primarily because of a sharp decline in interest payments and continued fiscal consolidation efforts. The improvement created additional fiscal space for development spending, subsidies and social-sector support.

Meanwhile, Pakistan’s external position strengthened further during the review period. Workers’ remittances remained robust, foreign exchange reserves increased to $16.1 billion and the exchange rate remained relatively stable. The current account deficit stayed contained despite a widening trade gap caused by stronger imports and weaker exports.

The report said remittances continued to play a critical role in financing Pakistan’s trade imbalance, supported by favourable labour market conditions in Gulf economies and measures aimed at encouraging formal remittance inflows.

Despite the improvement in key macroeconomic indicators, the central bank cautioned that structural weaknesses continued to limit Pakistan’s long-term growth potential. Low investment, weak export competitiveness, subdued foreign direct investment and a persistently low tax-to-GDP ratio remained major constraints on sustainable economic expansion.

The SBP also warned that geopolitical tensions, particularly the ongoing war in the Middle East, posed growing risks to Pakistan’s macroeconomic outlook through higher oil prices, supply-chain disruptions and inflationary pressures.

While the overall outlook for FY26 remained broadly stable, the report stressed that sustaining economic recovery would require deep structural reforms aimed at improving productivity, boosting exports and attracting investment into higher-value sectors of the economy.

Credit: INP-WealthPk