Navigating the Double-Edged Sword: Stagflation and Economic Policy in Pakistan
- Causes and Consequences of Stagflation: Pakistan's economy faces stagflation due to high inflation, slow growth, unemployment, energy crises, and structural inefficiencies, leading to reduced purchasing power, income inequality, and weakened investor confidence.
- Role of Institutional Reforms: Strengthening institutions, addressing corruption, improving governance, and fostering investment are critical to combating stagflation and driving sustainable economic growth.
- Proposed Solutions: Tackling the energy crisis, enhancing agricultural productivity, expanding social safety nets, and implementing structural reforms in fiscal and monetary policies are necessary to alleviate stagflation's impact and ensure long-term economic stability.
Stagflation is often described as a “silent killer” because whilst inflation exaggerates the cost of living, the slow economic growth does not keep pace, decreasing the purchasing power of the common man. This trifecta of economic issues creates a vicious cycle that is difficult to address with conventional economic policies. Pakistan is enduring a persistent dilemma characterized by stagflation, an economic cycle which includes high inflation followed by low economic growth. It possesses a significant challenge to economic policy makers and businesses with wide impacts on the population.
Major contributors to stagflation include sluggish growth, unemployment woes, high inflation rates, and many other supply-side constraints. Energy shortages and lack of accessibility to adequate resources also play a vital role in this regard.
According to FY 2024, economic growth projections have been revised downward, hovering over an estimate of 1.5%-2% while major sectors keep struggling with energy shortages. Inflation has been persistently high , as if exceeding 30% at the end of year 2024. High inflation erodes the value of currency, making exports more expensive and imports cheaper. The Pakistani rupee has weakened significantly against the US dollar, increasing the trade imbalances. It has led to higher import prices, further driving inflation. In response to inflation, the State Bank of Pakistan (SBP) has increased interest rates to around 22%-23%. But doing so in a stagnating economy can lead to further unemployment .
Stagflation and economic growth are linked intricately, with stagnating growth Deepening the conditions conducive to stagflation, the economy finds itself increasingly vulnerable to inflationary pressures and supply-side constraints. Based on research findings as outlined by the Pakistan Institute of Development Economics, youth employment requires more than 8% growth for the next 30 years .To achieve the preceding goal, the investment requirement must be at least 28.8%.
Law and order challenges, political instability, and extreme weather conditions sabotage any momentum we build for the prosperity of our state. Terrorist attacks in Baluchistan and Khyber-Pakhtunkhwa, surging street criminality, catastrophic floods, and scorching summers increase the plight of the impoverished who are already struggling with severe economic burden. Planning Minister Ehsan Iqbal ascribed Pakistan’s relentless fall on the SDG’s Index to the ‘2022’s mega climate disaster.’.
Fortifying institutions are crucial to building the foundation of investors confidence. Increasing investment opportunities stimulates economic growth, as a result reducing stagflation. Institutional problems such as weak governance and corruption, inefficient legal and judicial systems, weak financial institutions, low human capital development, and bureaucratic inefficiencies thwart the growth of a country. Several countries, such as Vietnam, China, and Cambodia, among others, show that the growth rate was increased by a small number of institutional and policy changes. Vietnam’s economy since the the 1980s has grown tremendously .The World Bank forecasts 6.1% growth in the year 2024.
‘Good institutions build strong nations; weak institutions lead to stagnation.’
Stagflation’s impact on Pakistan is far-reaching, undermining the economic and social aspects. Erosion of real wages, distorted consumer behavior, worsening income inequality, dampened business investment, increased pressure on social welfare systems, ineffective monetary and fiscal policies, and global impact on trade and investment, and compounding long-term structural weaknesses are only a few of them.
Stagflation is a crippling blow to national growth. Certain measures should be taken to combat stagflation effectively. The Pakistan Institute of Development Economics (PIDE) has called attention to several hypercritical factors contributing to stagflation in the country. One of the main reasons identified by PIDE is structural inefficiencies within Pakistan’s economy. The country faces a continuous mismatch between monetary and fiscal policies, leading to insufficient demand management. PIDE points out that using tight monetary policies has not had the best results in stimulating economic growth; rather, it provokes more stagflation. Secondly, Pakistan suffers from low investment-to-GDP ratios combined with deficiencies in trade and productivity sectors. Lack of investment , and private sector involvement, and weak export growth are pivotal in prolonging stagflation. According to PIDE, without addressing these bottleneck issues, Pakistan’s growth remains vulnerable, making it tedious to break through this vicious cycle of stagflation.
We need to address the energy crisis and improve productivity. According to PIDE’s research, Pakistan’s energy sector is burdened by circular debt, amounting to over PKR 2 trillion in unpaid dues. Strengthening social safety net issues is another key factor that needs attention in order to contribute to the reduction of stagflation. The current BISP reaches around 7 million families; expanding it and increasing allocations might mitigate the pain of inflation and reduce social unrest.
Structural reforms in agriculture must be used. Macro- and micro-level structural changes may help to revitalize the agricultural sector. Corporate farming and developing agri-industrial clusters may be a reliable option. Investment in the agricultural sector needs to shift from subsidy to demand-driven and problem-solving research. The expansion of the rural education network through agricultural-based vocational training institutes could help bridge the knowledge gap and improve productivity.
To conclude, Pakistan requires a nuanced and balanced policy approach to overcome the rising problem of stagflation. The combined problem of stagnant growth and persistent increases in prices requires urgent attention to both monetary and fiscal strategies. While short-term measures can alleviate the immediate impacts, a long-term focus should be placed on structural reforms. Only through an overarching and coordinated effort can Pakistan hope to reduce the complexities of stagflation, ensuring stability and necessary growth for future generations.
The author is pursuing an MPhil in Economics at the Pakistan Institute of Development Economics (PIDE) in Islamabad.
