Manager Research, PAGE

Feb 18 - 24, 2008

In Pakistan, periods of low inflation are associated with high growth rates and vice versa. Between 1978 and 1991, inflation was 8% on average and real per capita growth averaged 3%. Between 1992 and 1997, inflation increased on average to 11%, while real per capita growth fell substantially and averaged only 1%. Finally, between 1998, inflation was reduced again to an average of 5%, and real per capita growth displayed a dramatic recovery.

Inflation rate in Pakistan accelerated starting in late 2003. Following the 1998/99 crisis, inflation was reduced to below 5% by 2000 and remained stable through 2003. Tight monetary policy (combined with fiscal consolidation) appears to have contributed to this low-inflation environment. Inflation follows broad money growth and private sector credit growth closely with a lag of about 12 months. With monetary growth picking up, inflation followed and increased sharply in late 2003, peaking at 11% year-on-year in April 2005. Average annual inflation appears to have stabilized around 8-9% by September 2005. The acceleration of inflation also coincided with two increases in the wheat support price in September 2003 and in September 2004, which re-opened the debate whether the wheat support price was driving inflation in Pakistan.

Inflation reached as high as 9.28% in FY05 and then touching 7.91% in FY06 and 7.77% in FY07. The trend has not reversed and in FY08 it has further charged upward. The Consumer Price Index rose to 11.86% in January 2008 taking the cumulative figure for 7M/FY08 to 8.56% as compared to 8.14% in 7M/FY07.


Food inflation in the country ballooned to 18.25% in January, and it was the highest-ever monthly increase in the recorded history which hit the low income group, reducing their purchasing power. The overall inflation also increased substantially which witnessed a double digit increase of 11.86% in January over last year. It is not just food that is getting more expensive, the wholesale-price index (WPI), the most commonly used measure, rose to 15.53% in January, and again there was a highest-ever increase in the history.

Despite their adverse impact on the people from the low-income group, the steps taken by the government failed to reverse the trend so far, except the tightening of monetary policy by the State Bank of Pakistan to curb the growth in the core inflation. Having raised the interest rate many a times to curb the core inflation, the SBP governor had recently warned that an increase in the government borrowings would become one of the reasons for an increase in the core inflation.

Thanks to the government that oil prices in the domestic market are frozen, which helped control non-food inflation, which stood at 7.3% in January 2008. If there was an increase in oil prices, the non-food inflation would have easily touched the double digit figure.


There are several internal and external factors which have contributed to the recent pick up in inflation in Pakistan. These factors include: a sharp economic recovery resulting in a rise in the levels of income with the consequential surge in domestic demand; the continued pass through effect of the pervious rise in international oil prices; and a sharp pick up in the international prices of essential commodities.

High and persistent inflation is a regressive tax and adversely impacts the poor and economic prospects. The poor have little options to protect themselves against inflation. They hold few real assets or equity, and their savings are typically in the form of cash or low-interest bearing deposits. Thus, this group is most vulnerable to inflation as it erodes its savings. High inflation also inhibits financial development. Financial market institutions are intermediaries that reduce frictions between savers and investors (including adverse selection, moral hazard, or conflicting time preferences). Inflation makes this intermediation more costly because the inflation tax lowers long-run real returns. As a result, credit is rationed and financial depth is reduced. As in the case of growth, there appears to be a threshold beyond which inflation adversely affects financial sector developments, while there are no negative effects at low levels of inflation.

Pakistan's growth record since the 1970s underscores that high and persistent inflation is harmful to growth. Periods of high inflation have coincided with low growth spells, while high growth episodes tend to be associated with a low inflation environment.

The country has been progressing rapidly on the back of sound macroeconomic policies which have propelled the economy to its best performance for decades. While major economic fundamentals remain strong, rising international commodity prices and the consequent inflationary pressure pose some concerns to overall macroeconomic stability. The government has been vigilant about inflation and has taken various steps to release demand pressures on one hand and augment supplies of essential commodities on the other. To ease demand pressure the State Bank of Pakistan has tightened monitory policy over the last two years and to augment supplies the government has liberalized import regime and allowed imports of several essential items with a view to increasing the supply of those items.