Renewed Middle East tensions pose downside risks to inflation, external sector: finance ministry

ISLAMABAD: Anticipating the new fiscal year to begin with double-digit inflation, the government on Thursday expressed concern over renewed geopolitical tensions in the Middle East, saying they posed downside risks to inflation and the external outlook.

“Renewed geopolitical tensions in the Middle East pose downside risks to inflation and the external outlook,” the Ministry of Finance said in its Monthly Economic Update & Outlook (July 2026), while assuring that the external sector would remain resilient, supported by government measures to facilitate exports and sustain the strong momentum in remittance inflows.

“Overall, prudent macroeconomic management, fiscal discipline, ongoing structural reforms, stronger industrial activity and improved external buffers are expected to sustain the recovery in economic activity while preserving macroeconomic stability,” the finance ministry said, adding that macroeconomic stabilisation had largely been achieved in FY2026.

It said the economy was expected to maintain its growth momentum in the current fiscal year, supported by “improving macroeconomic fundamentals, continued expansion in the manufacturing sector, fiscal consolidation, resilience in agriculture and a stable financial environment”.

Manufacturing activity was likely to maintain its positive trajectory, underpinned by stable energy availability, easing financial conditions, improving domestic demand and continued export-oriented production, the ministry said.

“Inflation, however, is expected to remain elevated in the near term, with CPI inflation projected in the range of 9-10 per cent in July 2026.”

At the same time, it also warned that normalisation of global energy prices remained contingent on a durable and lasting peace agreement between the US and Iran.

Among high-frequency indicators, the US Weekly Economic Index (WEI), which measures real-time economic activity, stood at 2.9pc for the week ended July 18, while its 13-week moving average stood at 2.87pc.

Likewise, the ministry said the Composite Leading Indicator suggested that Pakistan’s major export markets (OECD economies such as the UK and the US) remained broadly aligned with their long-term potential of 100, indicating continued support from external demand, although renewed geopolitical tensions could pose downside risks.

The ministry said the government’s focus on poverty alleviation and social protection continued during the fiscal year that had just ended.

In June 2026, the Bureau of Emigration and Overseas Employment registered 38,410 workers for overseas employment, reflecting continued opportunities for Pakistani workers in international labour markets, it said.

The finance ministry noted that Pakistan’s economy entered FY2027 with an improved macroeconomic environment, as the stabilisation gains of FY2026 continued to support economic recovery and strengthen prospects for sustainable growth.

“In FY2026, average CPI inflation remained within the targeted range despite elevated global oil prices and supply chain disruptions.

“Large-scale manufacturing rebounded and agriculture maintained moderate growth despite weather-related challenges.

“Improved revenue mobilisation and prudent expenditure management further strengthened the fiscal position. The external sector remained broadly balanced, with the current account recording a marginal deficit of $140 million. Record-high workers’ remittances and higher foreign exchange reserves helped offset the import recovery associated with the strengthening of domestic economic activity.”

Meanwhile, it said IT exports reached a record $4.6 billion (up 20.6pc from last year), underscoring Pakistan’s growing potential in technology and digital services. Keeping in view these positive developments, S&P Global Ratings recently upgraded Pakistan’s long-term sovereign credit rating to B from B-, indicating improved institutional capacity, sustained implementation of reforms, improved fiscal performance and a significant rebuilding of foreign exchange reserves.

“With these gains continuing to advance the foundations for sustained economic growth, real GDP growth is targeted at 4pc in FY2027, based on the government’s continued advancement of the reform agenda through deepening financial markets, broadening the domestic investor base, strengthening debt sustainability and enhancing the country’s presence in the global capital market,” the ministry said.

Nevertheless, it warned that renewed US-Iran hostilities once again posed downside risks through global energy prices, trade and financial market volatility.

However, stronger macroeconomic fundamentals, improved external buffers, government readiness and continued policy vigilance have enhanced Pakistan’s capacity to manage such shocks effectively, the ministry concluded. ...