IMF & Pakistan’s Inflationary Conundrum

Author Name: Hassan Mujtaba       25 Nov 2020     International Economy

The economy of Pakistan is in hot waters once again. With the second wave of COVID-19 sweeping through the country, rising expenditure heads, and mounting debt obligations, it seems that the return to the International Monetary Fund’s (IMF) is inevitable. Indeed, in a recent statement, Adviser to the PM on Finance & Revenue Dr. Abdul Hafeez Shaikh confirmed that the stalled talks with the IMF’s Staff Mission are expected to resume soon, which will determine the future of Extended Fund Facility (EFF) and the release of the third tranche. If and when that happens, we can expect a second round of tight fiscal and monetary policies coupled with an increase in energy tariff, unrealistic tax targets, doing away with subsidies (that have artificially pumped the economy), and prolonged fiscal consolidation. This will keep Pakistan in a low-growth equilibrium—notwithstanding the exogenous COVID-19 shock—for a long time to come and which is confirmed by the gloomy growth projections of the multilaterals as well.

The main objective of the IMF’s Structural Adjustment Program (SAP) is to make a recipient country self-reliant by promoting economic growth and arresting inflation. But does their policy program achieve the desired results? Unfortunately, it does not! In fact, in most cases, it leads to outcomes that contradict the Fund’s stated objectives vis-à-vis growth, poverty alleviation, inflation and economic modernization.

One wonders at this apparent discrepancy between the Fund’s goals and its policy outcomes. Is it because of the ineptitude of the Fund’s staff? Or are there other structural and ideological factors underpinning the Fund’s agenda that tends to nullify macroeconomic stabilization? In my opinion, it’s the latter, as the Fund is manned by world-class economists and policy analysts.

The truth is that IMF—like other multilateral institutions—is an apostle of neoliberalism with an unstated mission to promote free-market capitalism, deregulation, trade-liberalization, labor market flexibility, and free-float currency policies. While some of these policies may work for the developed world, their efficacy for the Least Developed Countries (LDCs) is far more questionable. Take the case of inflation targeting as an example. The IMF subscribes to the ‘monetarist hypothesis’ which states that inflation is— always and everywhere —a monetary phenomenon. Translation: An increase in the disposable incomes of the common people causes a price hike irrespective of the country or region of the world. In LDCs like Pakistan, this theoretical construct (aka Quantity Theory of Money or QTM) is questionable as 98% of the country’s population does not have a bank account, which is an essential feature of M2, i.e., broad money supply. In addition, a plethora of studies conducted in the context of Pakistan have demonstrated that the one-on-one proportional relationship between M2 and Consumer Price Index—which is a necessary condition of the QTM—simply does not exist.

Conversely, Pakistan’s inflationary conundrum is resolved by applying the Structuralist Hypothesis, which views the supply side or cost-push factors as primary determinants of inflation. Indeed, supply-side variables such as oil prices, the unit value of imports, and wheat support (procurement) prices have played a larger role in inflation than the M2 in the monetary history of Pakistan. This is further confirmed by the fact that during civilian rule in Pakistan, inflation averaged 11%, while the M2 growth hovered around 13%. On the other hand, during the military regimes, inflation averaged 6%, while the M2 grew at a much higher 14%. The fact that the growth in money supply and inflation move in the opposite direction is sufficient empirical proof for the validity of the Structural Hypothesis in the case of Pakistan. In addition, the ‘structuralists’ case is further consolidated by a State Bank study which shows that a 1% increase in the discount rates (i.e., central bank’s interest rates) leads to a price hike by 0.7%. This means that any attempt to choke the aggregate demand fuels inflation in Pakistan’s context, which is contrary to the monetarists’ assertions, who contend that increases in the interest rates are a legitimate way to defuse inflationary pressures.

Little wonder then that policies of the IMF as part of its SAPs has fueled inflation in Pakistan— rather than arresting it—leading the Fund to nullify its structural macroeconomic objectives. Indeed, a study by Chaudhry and Choudhary (2006) concludes that Pakistani policymakers should not target inflation as part of monetary policy as it leads to severe economic downturns and inflationary pressures within the country. We saw a practical demonstration of this fact in the wake of the recent IMF SAP agreed upon by the incumbent government, which has led to high inflation, high unemployment, and dismal economic growth.

The Fund’s objective for low inflation is better achieved, by targeting supply-side factors, in particular food and agricultural commodities. This is because Pakistan is primarily an agrarian country where food items account for a substantial weightage (close to 41%) in the basket of goods used for calculating Consumer Price Index (CPI). Of this 41%, 6% of the weight is accounted for by wheat and wheat items. Small wonder then that any exogenous shock to wheat and other crops spiral food inflation which hits working poor the most. Thus, to control inflation, Pakistani policymakers need to smoothen the wheat & agricultural supplies by ensuring adequate stocks and by raising the productivity of the agriculture sector. This will also lead to a partial vindication of the monetarists’ arguments that inflationary expectations can lead to inflation, and thus, are necessary for its management.

Hassan Mujtaba is a Researcher in the Economic Affairs section of Centre for Aerospace & Security Studies (CASS). He can be reached at


Image Source; Pakistan Gulf Economist