Rising trade deficit

The release recently by the Pakistan Bureau of Statistics (PBS) of the summary on foreign trade for the first quarter of 2025-26 carries some warning signs. The trade deficit has risen sharply. The deficit was USD 7.0 billion in 2024-25 in the first quarter. It has risen by almost 33 percent in the first quarter of 2025-26. The trend on a monthly basis shows that the deficit has increased progressively in relation to 2024-25. It was higher by 17.7 percent in July, by 32.7 percent in August and 45.8 percent in September 2025.

The size of the trade deficit in absolute terms in the first quarter of 2025-26 is USD 9.4 billion. If this trend persists then the annual trade deficit in goods could exceed USD 36 billion. This will be higher by USD 9.7 billion in relation to the magnitude in 2024-25.

There is need to recognize that the impact of the recent devastating floods has not yet been seen in the balance of trade. The likelihood is that larger wheat and cotton imports will be required due to the floods. Exports of rice will be significantly lower and there could also be some impact on exports of textiles, due to reduced domestic availability of cotton. Overall, the impact of the floods on the trade deficit could be an increase of up to USD 5 billion.

The developments in the last three months are in sharp contrast to the expectations in the IMF Programme. The balance of payments projections in the Programme are based on a trade deficit in goods of USD 26.6 billion in 2025-26. This represents a marginal increase of only USD 0.3 billion over the level in 2024-25.

Unfortunately, already in the first quarter the trade deficit has risen by USD 2.4 billion over the level in 2024-25. Building in the impact of floods there is a real risk that the trade deficit in goods could approach USD 35 billion by the end of 2025-26. This will imply a considerable divergence from the external financing requirements projected for Pakistan by the IMF for 2025-26.

There is need to see which imports are demonstrating high growth in the first quarter of 2025-26. Disaggregated data is available only for July and August. Accordingly, palm oil imports have jumped by 29 percent, machinery by 23 percent, transport by 98 percent, and metal group by 18 percent. There has been no import of wheat and only USD 256 million imports of cotton.

The initial developments on the export front are an already 32 percent decline in rice exports. This has been partly countered by growth in textile exports of almost 10 percent.

The fundamental question which arises, given the deterioration already in the balance of trade in goods, is what measures need to be undertaken over next three quarters. This is necessary to prevent an increase in pressure on the foreign exchange reserves due to the big jump in the trade deficit in goods.

There is the likelihood that the on-going IMF staff mission to Pakistan must be focusing in the developments on the trade front. The IMF Programme expects the trade deficit in goods to be USD 26.6 billion in 2025-26, implying a quarterly average of USD 6.7 billion. The deficit has already risen to USD 9.4 billion in the first quarter, clearly indicating the need for strong policy actions in the next three quarters to limit too large the divergence from the IMF projection.

The first issue relates to the exchange rate. There has been extreme stability in the exchange rate since June 2024. This has been the outcome of a surplus in the balance of payments and support from the IMF, especially in 2023-24 and 2024-25.

There is now the risk that with a bigger trade deficit, the current account would go back from a positive to negative position, depending partly on the increase in home remittances. The growth rate of remittances in the first two months of 2025-26 has been a modest increase of 7 percent and a rise in absolute terms of only 0.4 billion USD. If this continues to be the path then strong measures will have to be taken to limit the size of the current deficit.

Estimation of the underlying projection by the IMF of the value of the rupee implies a significant devaluation of the rupee by 11 percent. Apparently, this adjustment is required even with the expectation of only a modest increase in the current account deficit of USD 3.6 billion in relation to the level in 2024-25.

Restriction of imports, especially of machinery, will require continuation of a relatively high policy rate of 11 percent. Further, measures will need to be taken to facilitate exports by tax facilitation and other measures.

Overall, the year 2024-25 had been a year of considerable consolidation and stabilization with the umbrella of an IMF Programme. The current account was converted into a surplus and the foreign exchange reserves rose to a level providing import cover of almost 3 months. With stability in the value of the rupee and other factors the rate of inflation was brought down to only 4.5 percent.

The outlook for 2025-26 is not so sanguine. There is the likelihood of a big jump in the trade deficit of goods as identified above leading to a return back to a significant negative current account balance in the balance of payments, especially with the impact of the floods.

The rupee may begin to depreciate and/or there will be a return to physical controls over imports.

We await the conclusion of the second review of the IMF Programme and the extent to which the balance of payments and external financing projections are changed by the IMF in light of the recent developments.

Copyright Business Recorder, 2025