Pakistan: Breaking Out of Stagflation into

Sustained Growth
The paper by Rashid et al. stipulates that throughout its history Pakistan has experienced high economic
growth when inflation levels were generally low especially after 1980. In 2007/08 till at least 2011 (when
the paper was published) Pakistan has experienced a new phenomenon in stagflation i.e. very low
economic growth along with very high inflation. It goes on to argue that this stagflation was a result of a
series of supply shocks:
1. Energy shortage
2. Rising oil prices
3. Floods in 2010
These supply shocks raised the supply curve and constrained output growth. On the other hand demand
pressures continued to rise due to:
1. Fiscal deficit financed by State Bank of Pakistan (SBP)
2. Foreign remittances
3. High price floors for cereals
4. Rise in Public sector wages
The seeds of this crisis were sown during the affluence of the Musharraf era. Growth during Musharrafs
regime was mainly consumption led spurred on by increase in remittances, foreign aid and easier access
to EU markets post 9/11. Macroeconomic fundamentals remained weak as no measures were taken to
balance supply side during this demand led roller coaster ride.
The series of supply shocks have raised the supply curve and policymakers are faced with tough
alternatives. Tightening money supply and raising interest rates to reign in prices might further constrict
output. On the other hand if the
government were to try to raise aggregate
demand via a fiscal stimulus it might result
in even higher inflation without a
corresponding rise in output.

IMF support was sought in 2008/09 to stabilize the economy by introducing flowing measures:
Reducing fiscal deficit by increasing tax revenues and reducing government spending
Raising interest rates from 13% to 15%
Depreciating the Rupee exchange rate to encourage net exports
However the government has failed in implementing effective tax reforms and curbing its expenses
resulting in undue pressure on investments both private and public. Lack of energy and the shaky law &
order situation decreased investor confidence; drying up investments. Between 2007/08 and 2010/11
investments dropped by 20% whereas consumption grew by 14.3%.
The price of wheat saw more than a 100% rise from PKR 450/40kg to PKR 950/40kg fuelling inflation.
Rise in wages and inability to withdraw government subsidies on fuel further aggravated the situation by
keeping the aggregate demand high. The fuel subsidies resulted in the now infamous circular debt.
Monetary policies have also largely failed to curb inflation due to the following reasons:
1. Supply shock due to 2010 floods
2. Interest rate has been the dominant monetary policy channel in Pakistan since 2005. Studies
show that this channels impact is weak and slow
3. Excessive government borrowing from SBP at high interest rates is in fact injecting liquidity into
the system thus increasing money supply instead of tightening it
The result of the high interest rates of SBP have been unsuccessful in deterring government borrowing
and the result has been increased cost of borrowing for the private sector. This has resulted in fewer
private investments and decrease in economic growth.
The Paper suggest four steps to break out of stagflation
1. Better Macroeconomic Management
Fiscal deficit should be reduced to allow the monetary policy to take effect. Policy
coordination between the provinces and center is important especially after provincial
autonomy. All economic decisions should be evaluated for impact on key
macroeconomic variables.
2. Fiscal Discipline with targeted Government led development
Tax base should be broadened and tax revenues expanded especially with the RGST.
Government spending should be minimized by eliminating all but the most critical
subsidize and development projects. Its important to achieve the delicate balance
between reducing government spending and spending on important development
projects without which the countrys long-term competitiveness would be
compromised.
3. Prudent Monetary management to Spur Private sector
The monetary policy should be adjusted to revive economic growth in the country led by
the private sector.
4. Social Safety Nets
Income support programs like the BISP and judicious utilization of zakat is important to
alleviate poverty and maintain buying power during the tough period of stagflation.