While Pakistan’s economy remains on a high-growth trajectory during FY06, the real GDP growth rate for the year seems increasingly likely to be lower than the 7 percent target. The expectation of the slowdown relative to the FY06 annual target owes principally to the (estimated) weaknesses in the commodity producing sectors of the economy, the impact of which will be partially offset by an anticipated above-target performance of the services sector.

It is important to understand here that the forecast deceleration in economic activity during FY06 does not trend growth of the economy. With the substantial investments in the current (and preceding) year, strong domestic demand, buoyant exports and a relative improvement in FDI (even after excluding privatization receipts), the economy is poised to deliver real growth rates in excess of 6 percent through the decade, provided that progress is made towards removing infrastructural bottlenecks, implementing second generation reforms to improve institutions and governance, as well as to further liberalize the economy. Moreover, in the short-run, it would be necessary to address emerging macroeconomic imbalances while these are still small and not threatening.

Some of the key macroeconomic imbalances include the downtrend in savings that has led to a widening savings investment gap, the growth of the trade deficit (and concomitant rise in the current account deficit) and, a weakening in fiscal indicators (even after adjusting for exceptional earthquake related spending). Also while inflationary pressures show a very welcome decline, the downtrend is still unsettled, and inflation remains at relatively high levels.

While inflation has declined from double-digit near term highs in FY05 and is expected to fall to the 8 percent levels by end-FY06, it must be recognized that reducing it further is necessary for a host of reasons. These include the need to encourage a rise in savings (by keeping real returns on savings positive), maintaining the purchasing power of incomes, making exports more competitive (by holding down the cost of production and thus lowering pressure on the exchange rate), etc.