Avoiding Stagflation: Pakistan’s Never Ending Challenge

Author Name: Ali Haider Saleem       15 Nov 2021     Domestic Economy

Pakistan’s economic challenges are widening and it is looking for external support to keep the situation under control. Recently, the government was able to revive the economic support package from Riyadh. While this approach can stabilize the economy in the short run, its effect will subside with the passage of time leaving a large segment of the population with more uncertainty and financial burdens. Pakistan’s economy has been performing below its potential for a number of years and the growth rate has not been sufficient to absorb the growing population which has resulted in rising unemployment. External factors such the COVID-19 pandemic, rising commodity prices and climate change have also adversely impacted the economy and hampered efforts to spur economic growth.

Hence, the country’s economy is struggling to attain stability and consistent growth. Recent indicators suggest that it is going through a period of stagflation which basically means that the economy is growing at a slow rate but inflation and unemployment are relatively high. In October 2021, the rise in inflation was 9.2% compared to last year, while the unemployment rate in the current fiscal year is projected to be 4.8%. Economic growth has been sluggish and is projected to be only 4% in financial year 2022. In the previous year, the growth rate was even less. In comparison, many countries saw a sharp rise in their economic growth rates after COVID related restrictions eased - India’s economy grew 9.5% while China’s economy expanded by 8% last year. The low base effect will dissipate in the current fiscal year but the economies of India and China are expected to grow by 8.5% and 5.6% respectively.

Stagflation is not a very rare situation and many countries, including Pakistan, have gone through such periods. The oil crisis in the 1970s saw many advanced economies suffer from high inflation and unemployment while their output plummeted. Usually, such scenarios emerge due to exogenous factors and also go against many accepted economic theories such as the Phillips Curve which illustrates that there is a trade-off between unemployment and inflation. In other words, policies aimed at addressing unemployment are likely to increase inflation. Other contradictory situations also turn up, for example depreciation of the currency makes a country’s exports more competitive but it also raises import bills which for import-dependent economies like Pakistan is quite harmful.

Pakistani policymakers find themselves in a difficult position as they have limited options at hand. Last year, the interest rate was significantly brought down to boost economic activity but the increase in global commodity prices hampered economic output while exerting further inflationary pressure. On top of that, the IMF program has also proven to be burdensome for the economy. Under the program, the government has been under extensive pressure to raise taxes and reduce subsidies which has dented output and also raised prices. Moreover, the present circumstances have created an uncertain environment which is discouraging for investors.

However, Pakistan is not the only country that is facing such a severe situation. Low output, accompanied with rising costs and joblessness, is prevalent in many parts of the world. Some experts have argued that the global economy is not facing stagflation. According to Carl Weinberg, ‘We’re seeing an adjustment to new temporary realities on the supply side but we’re not seeing the stagflation process that we saw in the 1970s recurring again.’ He believes that the situation will improve as the supply chains will overcome the disruptions caused by the pandemic. Gita Gopinath, IMF’s Chief Economist acknowledges that growth is slowing and inflation is on the rise but she also ruled out the possibility of stagflation. She asserted that the US economy has rebounded which usually has a positive spillover effect on other economies. However, she warned that rising inflation could lead to tightening of US fiscal policy which ‘could have negative spillovers to emerging and developing economies, especially those who are relying heavily on external financing for borrowing foreign currency, and don’t have very deep trade relations with the U.S.’

Based on their assessments, strong and competitive economies will be able to recover but countries like Pakistan will continue to struggle. Supply-side constraints and mismanagement are the main factors that steer an economy towards stagflation. Unfortunately, Pakistan’s economy has been a victim of both. In recent years, Pakistan’s share of exports has consistently fallen, whereas imports have seen a sharp rise. Alarmingly, the trend is persisting even when many other countries have started to show positive signs of recovering from the pandemic. In the first quarter of the Financial Year 2021-22, Pakistan’s exports were almost USD7 billion, whereas the imports were recorded at USD18.6 billion. Widening trade deficit shows that weakening of the currency has also not proven to be beneficial.

Although exogenous factors are steering the economy towards stagflation, the solution lies in internal adjustment and improvements. Improving productivity and creating value added products is necessary to survive in the modern globalized economy. Moreover, the cost of production has to be lowered and reliance on imported fuel, equipment and raw materials has to be cut down. The global energy crisis has further exposed Pakistan’s economic foundations.

It is high time Pakistan begins adopting innovative approaches and enhancing the share of renewables in its energy mix. These measures will help the country to reduce its import costs while simultaneously improving productivity. Lastly, fiscal discipline must be ensured to break the cycle of entering into IMF programs every now and then to stay clear of stagflation in the future.

Ali Haider Saleem is a researcher at Centre for Aerospace & Security Studies (CASS), Islamabad, Pakistan. He can be reached at cass.thinkers@gmail.com.

Image Source: The Financial Express. (2020, July 10). Ensuing recession and major economic downturns. https://thefinancialexpress.com.bd/views/ensuing-recession-and-major-economic-downturns-1594402612

 

 

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