Pakistan Bulletin

An up-to-date and informed analyses of key issues of Pakistan.

Inflation, Growth, and Poverty

April 2024

With extraction of resources by the powerful groups embedded in Pakistan’s history, and little political willingness towards structural reforms, the country is currently experiencing a combination of low growth with high inflation, known as stagflation.

Pakistan is experiencing greater than 15 per cent inflation in the consumer price index (CPI) since June 2022. While the intensity of inflation has come down from its peak of 38 per cent in May 2023 to 20.7 per cent in March 2024, high inflation is persisting for the last 21 consecutive months. The bad news is that this trend may continue for some more months.
In its inflation history, the country has witnessed a duration of 28 months (from July 1973 to November 1975) when CPI inflation persisted at above 15 percent but with a peak of 29.3 per cent. One can only hope that the inflation history (of greater than 15 per cent) does not repeat itself in terms of the length of that spell. If we mean high inflation to be double-digit (10 per cent, or higher,) then the spell of high inflation lasted for almost 46 consecutive months during 1972 to 1976.

The World Bank's recent estimate puts the lower-middle-income poverty rate at 40.1 percent for 2024. This implies that there will be an additional seven million people living in poverty in 2024 compared to 2018.

Another episode of inflation pertained to the period of global financial crisis of 2008. The consumer price index inflation in Pakistan went above 10 per cent in January 2008, and after touching a peak of 26.1 per cent, started declining but stayed over 10 per cent for 18 consecutive months till June 2009. Only after five months, inflation again crossed the single digit and stayed at higher levels for almost 30 consecutive months till June 2012.

These episodes of high inflation show that once inflation starts spiraling, it is not only difficult to bring it down, it also takes a long time to do so. This is one of many reasons that central banks around the world pursue an objective of maintaining price stability around a low single digit inflation figure.

Inflation is not the only malaise that is hurting the nation. With the onslaught of high inflation, Pakistan’s real GDP declined by 0.2 per cent in Fiscal Year 2023, and expected to grow around 2 per cent in Fiscal Year 2024. This is a combination of low growth with high inflation, known as stagflation.
The inflation history cited above was accompanied by high growth of 6.8 and 7.5 per cent respectively in 1973 and 74. As such, economic situation is much worse now, perhaps the worst, in the country’s history in terms of low growth and high inflation. This combination is playing havoc with the poverty situation in Pakistan. While Pakistan had commendably reduced its poverty rate between 2001 and 2018, this progress has slowed down due to macroeconomic instability, the COVID-19 pandemic, devastating flood of 2022, and the unending political polarization. The World Bank has recently estimated the lower-middle income poverty rate at 40.1 per cent (US$3.65/day 2017 purchasing power parity) for Fiscal Year 2024 which is about the same as poverty rate in 2018. This means that there will be 7 million more poor in 2024 compared with 2018.
What should be done to reduce inflation, increase growth, and reduce poverty? Reducing inflation requires both tight monetary and fiscal policies. While the State Bank of Pakistan (SBP) had been maintaining a tight monetary policy with historic high interest rates, fiscal policy remained lax in terms of high fiscal deficits and government borrowing from commercial banks. Unless the government achieves a surplus in its primary balance, fiscal policy will remain lax.
The good news is that under IMF Stand-by Arrangement, fiscal authorities have shown some prudence and the first two quarters of the Fiscal Year 2024 showed a surplus of 1.4 per cent of GDP in the primary balance while maintaining a fiscal deficit of 2.3 per cent of GDP. This means that the continuity in monetary prudence is likely to further decrease inflation. However, history has shown that reducing inflation takes a long time, and any policy missteps run the risk of resurgence in inflation.

Growth promotion requires an increase in investment, both domestic and foreign, and an increase in productivity. While there is a lot of talk about attracting foreign investment, there is dearth of focus on attracting domestic investment. Promoting domestic investment requires, among many other factors, lower interest rates that can only emerge after inflation trajectory continues to show downward direction. Therefore, it is believed that continuity in prudent macroeconomic policies will lead to lower inflation and lower interest rates conducive for higher investment. Both fiscal and monetary prudence will promote domestic savings, necessary for domestic investment. The Government has already engaged IMF to secure a new medium-term program that will increase the likelihood of policy prudence, at least for that period. If the government also succeeds in initiating and implementing economic reforms pertaining to resource mobilization, expenditure management, resolution of circular debt, exchange rate management, and the public debt management, it can put Pakistan’s economy on a sustainable path of economic growth and development.

Democracy and inclusive political institutions are often considered positive factors in generating support for more liberalized economic reforms in product, labour, and financial markets. It is strong and popular governments that can garner support for structural reforms.

It is well-known that implementing economic reforms is a difficult but doable task as the experience of several countries has shown. In Pakistan, the process of reforms is more difficult because of the political economy of resources capture by powerful groups in the economy popularly labeled as the “elites.” The UNDP Pakistan National Human Development Report 2020 identifies seven such groups, consisting of the feudal class, corporate sector, exporters, large traders, high-net-worth individuals, the military establishment, and the State Owned Enterprises. These groups combined took privileges amounting to seven per cent of GDP. Pakistan’s economic system serves their interest through concessions in the tax system, the provision of cheaper inputs, higher output prices, and preferential access to land, capital, and infrastructure. Economic incentives directed towards these groups are not helping but retarding the productivity of our economy. Research done at the Pakistan Institute of Development Economics shows that it is not only growth but also the total factor productivity of our economy that is on the declining path.

Will the government succeed in implementing reforms with the above political reality?

Extraction of resources by the powerful groups is embedded in Pakistan’s history. International research on the political economy of structural reforms shows that these reforms could lead to large distributional consequences. This means that reforms will divert resources from these seven groups to those outside them (the small and medium non-corporate sector, the common people, and poor segments). Therefore, it would be unlikely for the government to have support from the seven groups. This, unfortunately, shows the near impossibility of implementing these reforms in the current political environment. Democracy and inclusive political institutions are often considered positive factors in generating support for more liberalized economic reforms in product, labour, and financial markets. It is strong and popular governments that can garner support for structural reforms.

Riaz Riazuddin


The author is a former Deputy Governor, State Bank of Pakistan.

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