SBP says Middle East war poses major risks despite stronger FY26 first-half indicators

ISLAMABAD: Pakistan’s macroeconomic position improved during the first half of fiscal year 2025-26, but the war in the Middle East has created serious risks for the country’s economic outlook, according to the State Bank of Pakistan (SBP).

The central bank on Tuesday released its Half Year Report 2025-26, titled The State of Pakistan’s Economy, saying the economy showed greater stability in the first six months of the fiscal year despite challenges stemming from uncertainty in global trade and domestic flooding.

In a press release issued with the report, the SBP said the conflict in the Middle East poses significant risks to the macroeconomic outlook. Likely supply chain disruptions could affect the path of inflation, external trade, remittance inflows and overall economic activity.

Growth outlook and inflation risks

Discussing the outlook for FY26, the latest readings from high-frequency indicators, including the Purchasing Managers’ Index, large-scale manufacturing and construction, showed that economic activity retained momentum through February before the war started weighing on output in the remaining month of FY26.

The SBP said it now expects real GDP growth to remain close to the lower end of its earlier forecast range of 3.75 to 4.75 per cent for FY26. Despite continued momentum in economic activity and higher commodity prices, the current account deficit is now projected to stay near the lower bound of the previously estimated range of 0-1pc of GDP.

At the same time, the report warned that a jump in international oil prices and its spillover effect on other commodity prices is likely to keep National Consumer Price Index inflation above the upper limit of the medium-term target range of 5-7pc for most of FY27.

First-half performance

Key economic indicators showed marked improvement in the first half of FY26. Average NCPI inflation declined further, while the SBP’s foreign exchange purchases and net financial inflows helped strengthen external buffers.

The SBP particularly pointed to its cautious monetary policy stance and said improved macroeconomic stability helped support growth momentum.

Real GDP in H1-FY26 expanded at twice the pace recorded in the same period a year earlier, led mainly by a recovery in industrial activity, followed by services and agriculture.

Stronger economic activity also led to a rise in imports in volume terms during the first half of the fiscal year. However, export earnings fell because of a sharp decline in rice exports. Steadily increasing workers’ remittances continued to finance a large share of the deficits in trade, services and primary income, helping keep the current account deficit at moderate levels.

The SBP also said lower interest payments and fiscal consolidation measures turned the fiscal balance into a surplus in H1-FY26 for the first time since FY02, while the primary surplus remained unchanged from last year’s level.

Inflation stayed moderate during the first half of FY26 because of a continued prudent policy mix, an improved external account position, exchange rate stability, softer international commodity prices and downward revisions in administered electricity tariffs.

Need for reforms and climate concerns

The central bank said that although overall economic conditions had improved, Pakistan’s shift towards a sustainable high-growth path with lasting macroeconomic stability would require deep-rooted reforms.

According to the SBP, these reforms need to tackle long-standing weaknesses including low savings and investment, weak competitiveness, declining exports, subdued foreign direct investment and a persistently low tax-to-GDP ratio.

The report also contains a chapter titled Climate Change and its Impact on Pakistan’s Economy. It says Pakistan’s contribution to global greenhouse gas emissions is very low, yet the country is the 15th-most affected by climate events. It adds that Pakistan faces high vulnerability to climate change and has low preparedness to deal with the resulting challenges.

The report also noted Pakistan’s relatively high emissions intensity of GDP, which it said reflects structural inefficiencies and a carbon-intensive growth path. It stressed the need for major investment in climate mitigation and adaptation, saying such financing remains largely unmet because of low international climate inflows and difficulties in mobilising domestic public and private sector funding.

The SBP said the report also examines the multiple macroeconomic risks to the medium-term outlook in the event of a prolonged war in the Middle East.

Last week, the Ministry of Finance and the SBP expressed optimism about economic growth and the achievement of fiscal and current account targets despite the regional crisis. In April, SBP Governor Jameel Ahmad said the ongoing conflict had introduced new risks and heightened uncertainty around the macroeconomic outlook, but added that the economy was in a relatively better position than in previous crises to manage these challenges.