KARACHI - The State Bank of Pakistan said yesterday that it expects an economic boost as the security situation improves.

The bank released annual report on the state of the economy for the fiscal year 2014-15 that ended on June 30, saying key macroeconomic indicators showed improvement during the year.

The government has estimated that a battle against extremism in the country has cumulatively cost some 8.7 trillion rupees ($85 billion) since 2001, an amount equal to one third of GDP in 2015.

The December 16, 2014 attack on a school in Peshawar, in which Taliban insurgents gunned down more than 150 people, galvanised broad support for decisive action against militancy, the report said.

The military intensified an ongoing offensive against militants and the government launched a sweeping plan to tackle extremism in the wake of the attack.

Levels of militancy-linked violence dropped dramatically, with 2015 on course for the fewest deaths among civilian and security forces since 2007. “We expect the elimination of a major threat to national security would also take out one of the most important growth-retarding factors for the country,” the bank said.

The government has predicted GDP will grow by 5.5 percent in the current fiscal year ending June 2016, compared to 4.2 percent last year, but the bank was more cautious, predicting growth of 4.0-5.0 percent.

The fiscal cost of fighting extremism may not fall immediately, the bank warned, but “we expect the relatively stable security situation in the country would help in rebuilding business and investor confidence”.

The SBP report says the real GDP growth increased to 4.2 percent in FY15, and key macroeconomic indicators like inflation, fiscal balance and current account balance recorded improvements.

The report recognises the fiscal consolidation efforts of the government in terms of controlling expenditure and points out structural weaknesses in tax collection. As per the report, a sharp decline in oil prices and subdued manufacturing activities during the year made already sluggish tax collections more difficult. The provincial budget surplus also recorded lower than the last year.

The report stresses improvement in the external sector. The external account improved due to a robust growth in workers’ remittances and a sharp decline in global oil prices. As a result, not only the country’s forex reserves reached an all-time high level of $18.7 billion by end-June 2015, sufficient to finance around 5 months of the country’s import bill, the exchange rate also remained stable during the year. More importantly, the improvement in the external account significantly diluted the global risk perception for Pakistan.

The report further explains that the stable PKR parity kept CPI inflation under control and lowered inflation expectations in the country. However, the significant reduction in CPI inflation during the FY15 was caused primarily by a sharp decline in oil and other commodity prices. The average CPI inflation fell from 8.6 percent last year to only 4.5 percent in FY15. A stable outlook of inflation and balance of payments allowed policymakers to implement pro-growth strategies.

For example, SBP cut its policy rate by a cumulative 350 bps during the year to boost investment activities. Similarly, on the fiscal side, development expenditures by the government remained strong through the year, focusing mainly on infrastructure development.

In order to finance the budget deficit, the government relied heavily on commercial banks, the report says. However, encouragingly, the government retired a large amount of its debt to SBP. In the meantime, SBP continued liquidity injections to ensure adequate supply of loanable funds for the private sector. Working capital utilisation declined due to drop in commodity prices.

A redeeming feature has been the increase in long-term financing which indicates new investment in plant and machinery. Nevertheless, the overall credit to the private sector remained lower than that in the previous year.

According to the report, the country was able to marginally reduce its public-debt-to-GDP ratio mainly due to revaluation gain from US Dollar appreciation against major currencies. The reduction in debt burden was realised despite the successful launch of five-year Sukuk bond in November 2014, which allowed the government to raise US$ 1.0 billion against the initial target of US$ 500 million.

While the report welcomes positive developments in the economy, it reiterates several long standing structural constraints, i.e. low investment rate, low tax-to-GDP ratio, and continuing energy shortages that continue to hinder a sharp economic recovery.

The report recognises that the improvement in macroeconomic conditions and security situation offers an opportunity to address structural impediments to economic growth on priority basis. Furthermore, the report underlines the need to pursue an effective and well-coordinated industrial policy to expand industrial and export base. Increasing exports is critical for resolving forex constraints to growth, the report concludes.