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Pakistan’s Inflation Controversy: Understanding the Factors Behind the Surge

In recent months, Pakistan has experienced a significant surge in inflation, reaching its highest levels in fifty years. Many economists have attributed this inflation to excessive aggregate demand resulting from large recovery packages, while others argue that it is a transient issue driven by supply disruptions. In this article, we will delve into the different perspectives on Pakistan’s inflation and the factors that contributed to this surge.

The IMF’s Stance

The International Monetary Fund (IMF) recently approved the release of SDR828 million (approximately $1.1 billion) under the standby agreement for Pakistan. The IMF’s Deputy Managing Director and Chair, Antoinette Sayeh, stated that the State Bank of Pakistan’s tight monetary policy stance is appropriate until inflation returns to more moderate levels. However, Sayeh’s statement reflects the IMF’s cookie-cutter approach to macroeconomic stabilization programs and may not fully address the complex factors behind Pakistan’s inflation.

Diverging Views on Inflation

Economists have diverged into two camps when explaining Pakistan’s inflation surge. The first camp attributes it to excessive aggregate demand resulting from large recovery packages. The second camp argues that the inflation is a transient issue driven by supply disruptions rather than excessive demand. Nobel laureate economist Joseph Stiglitz supports the latter perspective, emphasizing that the self-correcting trajectory of car and house prices indicates that the inflation is transitory.

The Role of Supply Disruptions

The surge in oil prices by about 40% following the Russian invasion of Ukraine in February 2022 contributed to a global inflation surge. Pakistan, being an energy-importing country, was particularly affected by this energy price shock. Additionally, supply disruptions in the post-pandemic world, coupled with higher energy prices, further impacted the inflation rate in Pakistan. It is important to note that the surge in inflation was not solely driven by a surge in demand for food items or home utilities.

The Impact on Pakistan’s Economy

Pakistan experienced a sudden spike in its year-on-year consumer price inflation (CPI) rate, with food, utilities, and transport being the key contributors. The annual average inflation rate surged to 21.32% in June 2022 from 9.65% in just twelve months. The rise in international oil prices and higher imports of medicines due to Covid-19 contributed to Pakistan’s current account deficit and a significant decline in foreign exchange reserves. This ultimately led to a currency crisis in the summer of 2023.

IMF Bailout and Stability

Pakistan secured the IMF’s standby facility in July 2023, which helped stabilize the currency and bring down the inflation rate. However, given that Pakistan’s inflation surge was largely driven by supply-side factors and there has been a contraction in economic activity and industrial production, a case can be made for a gradual easing of monetary policy and cuts in the policy rate to facilitate economic recovery from the shocks experienced in 2022-23.

Conclusion

Understanding the factors behind Pakistan’s inflation surge is crucial in formulating effective economic policies. Supply disruptions and higher energy prices played a significant role in driving the inflation rate, while excessive aggregate demand may not be the primary driver. As Pakistan aims for economic recovery, a gradual easing of monetary policy and cuts in the policy rate may be necessary to support the country’s growth.

Source: The News