ISLAMABAD: The International Monetary Fund (IMF) has warned that Pakistan faces renewed inflationary and financial stability risks from the prolonged Middle East conflict, with rising food and energy prices, higher borrowing costs and mounting external financing pressures threatening macroeconomic stability and potentially forcing further monetary tightening.
In its latest report “Regional Economic Outlook, Steering Through Uncertainty: Strengthening Resilience in Challenging Times”, the IMF stated that concerns about rising government debt could also lead to higher government borrowing costs than in the baseline, heightening fiscal sustainability concerns in countries with large gross financing needs, like Algeria, Egypt and Pakistan.
The IMF has cautioned that Pakistan may need to tighten monetary policy further if inflationary pressures intensify, particularly as real policy rates fall below estimated neutral levels.
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“If inflationary risks materialise, monetary policy should be the main line of defence. Although baseline forecasts generally point to moderating inflation in the Middle East and Central Asia from 2027 onward, authorities should remain prepared for renewed price pressures if the Middle East conflict persists longer than assumed and the adverse scenario materialises.
Countries should stand ready to tighten monetary policy, particularly where inflation is already above target and the policy stance appears accommodative, with ex-ante policy rates below estimated neutral levels, a combination most evident in the Kyrgyz Republic and Pakistan. Where fiscal space is limited, authorities should avoid using fiscal stimulus to offset the impact of tighter monetary policy”, the report noted.
It further stated that authorities should stand ready to safeguard financial stability amid downside risks. Financial supervisors should continue to monitor bank liquidity and funding conditions, asset quality in the sectors most exposed to the conflict—tourism, transport, and trade-related activities—and sovereign-bank linkages where public debt is elevated (Bahrain) and banks hold large stocks of government securities (Egypt, Pakistan, Tunisia).
Liquidity pressures emerge, support should be temporary, well targeted, and provided against adequate collateral, with a clear exit strategy. In economies with flexible exchange rates, foreign exchange intervention should be reserved for disorderly market conditions. Exchange rate flexibility can help preserve reserves and facilitate external adjustment (Egypt, Pakistan) but may also increase inflationary pressures through higher import prices.
The appropriate balance between exchange-rate adjustment and monetary policy tightening will depend on country circumstances. Where external buffers are thin and financing needs are large, credible macroeconomic frameworks and transparent communication can help contain risk premia and preserve market access, it added.
The Fund noted that Pakistan was the only country among MENAP economies with flexible exchange rates to raise interest rates after the conflict began in February 2026. However, it stressed that monetary authorities must remain vigilant against renewed price pressures stemming from higher energy and food costs, exchange-rate movements and potential second-round inflationary effects.
Pakistan’s economic activity has remained broadly resilient during the first half of 2026, with growth largely in line with the second half of 2025. Remittances have remained broadly stable, while tourism-related indicators have also held up. Financial conditions have been supportive, with exchange-rate depreciation pressures contained and capital outflows largely dissipating following their initial emergence after the conflict began.
However, the inflation outlook has deteriorated. Consumer inflation in Pakistan rose to 11.1 percent year-on-year in August 2026, reflecting higher food and energy-related prices. The IMF expects inflation to accelerate in 2026 across most oil-importing economies in the region, while its projection for Pakistan has been revised upward by 1.5 percentage points compared with its April forecast.
The Fund expects inflation to decline from 2027, but at a slower pace than previously anticipated, underscoring the challenges facing monetary authorities as they attempt to contain price pressures without derailing economic recovery.
The IMF said Pakistan’s growth projections for 2026 remained broadly unchanged from April, even as emerging-market and middle-income oil-importing economies are collectively expected to grow by 4.2 percent, compared with 3.9 percent in 2025. The regional improvement is largely driven by stronger projections for Egypt and Tunisia.
Over the medium term, Pakistan’s growth prospects are expected to benefit from continued macroeconomic stabilisation, structural reforms and sustained inflows from remittances. However, the Fund warned that Pakistan’s external position could weaken as imports increase and remittance growth moderates.
Over the medium term, external positions should strengthen in Egypt, Jordan, and Morocco, supported by lower commodity prices and export diversification, but weaken in Pakistan as imports rise and remittances moderate.
The IMF expects Pakistan to maintain a restrictive fiscal stance in 2026 because of limited fiscal space, even as several other regional economies loosen their budgets to cushion households and businesses against higher energy and food prices.
Tighter global financial conditions could expose fiscal and financial vulnerabilities. A reversal of market sentiment would tighten global financial conditions, eroding a key supporting factor for many economies in the Middle East and Central Asia so far in 2026. Higher oil prices than in the baseline would reignite inflation concerns and force major central banks to raise interest rates higher and for longer than currently assumed.
In countries where banks rely more heavily on external funding or hold large amounts of government securities, an abrupt repricing of financial assets could further reduce lending to the private sector, weaken investment and growth, and reinforce adverse feedback loops between fiscal vulnerabilities, banking systems, and the real economy. Economies reliant on external financing and weaker external positions could face capital outflows, exchange rate depreciation pressures, wider sovereign spreads, and tighter domestic financial conditions.
The war that started in February 2026 in the Middle East and the closure of the Strait of Hormuz—a critical trade artery—have disrupted global supply chains, pushed up commodity prices and inflation expectations, and prompted major regional central banks to adopt a more cautious stance. In Egypt, Jordan, Kazakhstan, Morocco, and Pakistan, monetary authorities flagged upside inflation risks from energy, food, and exchange rate pressures, underscoring vigilance against second-round effects.
Copyright Business Recorder, 2026
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