Inflation Targeting in Pakistan: Are Traditional Tools Failing or Fueling Economic Crisis? (2010-2024)

Introduction

Inflation targeting in Pakistan has been a controversial issue ever since it was formally embraced in the early 2020s. The State Bank of Pakistan (SBP) tried to stabilize prices by committing to an explicit inflation target (5-7%). But high consumer prices and economic instability bring a pertinent question. Are old inflation-targeting instruments effective, or are they aggravating Pakistan’s economic crisis?

Between 2010 and 2024, Pakistan experienced repeated shocks. Energy crises, floods, political unrest, and spikes in global commodity prices—that challenged the efficacy of monetary policy. Through an analysis of interest rates, exchange rate policy, and fiscal constraints, this blog considers whether inflation targeting has worked or failed in Pakistan

Understanding Inflation Targeting in Pakistan

What Is Inflation Targeting?

Inflation targeting (IT) is a monetary policy where a central bank

• Sets a public inflation target (e.g., 5-7%).
• Uses interest rates and open market operations to control money supply.
• Maintains transparency to guide market expectations

Pakistan adopted IT to curb hyperinflation, but has it worked?

Inflation Trends in Pakistan (2010-2024)

1. Pre-Inflation Targeting Era (2010-2020)

Before formal inflation targeting in Pakistan, inflation was volatile due to:

• Energy shortages (circular debt, power breakdowns).
• Fiscal deficits (government borrowing from SBP).
• Exchange rate instability (PKR devaluation).

Inflation Under IT (CPI % & Policy Rate

Exchange Rate Pass-Through Effect on inflation targeting in Pakistan

Critical Analysis:

• 60% of inflation increase due to currency depreciation.
• Energy imports became 3 times more expensive over 4 years.
• IT framework did not accommodate volatility in exchange rates.

Structural Failure Points

1. Policy Design Flaws

• Inflexible 5-7% target overrode Pakistan’s supply-side weaknesses.
• No escape clauses for exogenous shocks (floods, COVID, Ukraine war).
• Relying excessively on interest rates and blindingly ignoring fiscal-monetary conflict.

2. Implementation Gaps

• Absence of central bank independence: SBP compelled to finance deficits.
• Incoherent policy: 22 rate increases since 2021 with no fiscal adjustment.
• Limitations of data: Weak CPI basket coverage (underweights food/energy).

Are Traditional Inflation-Targeting Tools Working in Pakistan?

1. Interest Rate Hikes: Effective or Harmful?

• Theoretical framework: Explain that higher interest slow borrowing cut demand and curb inflation
• In case of Pakistan:

1. Aggressive hikes (2022-2024): Rates jumped from 7% to 22%.
2. Result: Inflation remained high, but growth collapsed (GDP ~1-2%).
3. Problem: Cost-push inflation (supply shocks) doesn’t respond well to rate hikes.

2. Exchange Rate Flexibility: Boon or Bane?

Theory Behind : Market-driven pkr should balance import/export.

In Pakistan:

• Sharp depreciation: PKR fell from 155/USD (2020) to 280/USD (2023).
• Impact: Imported inflation (fuel, food prices surged).
• Conclusion: Exchange rate adjustments worsened inflation targeting in Pakistan

3. Fiscal Dominance: The Biggest Obstacle

• Problem: Government borrows heavily from SBP, undermining monetary policy.
• Examples:
  • Subsidies & price controls (distort inflation signals).
  • Taxation issues (indirect taxes fuel inflation).
• Result: Inflation targeting in Pakistan fails without fiscal discipline.

Case Against Inflation Targeting in Pakistan

1. Structural Issues Limit Effectiveness

• Supply-side bottlenecks (energy shortages, hoarding, transport delays).
• Food insecurity (floods, poor agricultural policies).
• Informal economy (40%+ GDP untaxed, unregulated).

2. External Shocks Overpower Monetary Policy

• 2022 Floods → Food inflation hit 40%.
• Ukraine War → Fuel prices doubled.
• Global inflation → Imported inflation unavoidable.

3. High Interest Rates Stifle Growth

1. Businesses suffer: Loans become unaffordable.
2. Unemployment rises: Firms cut jobs due to high borrowing costs.
3. Stagflation risk: Low growth + high inflation = economic paralysis.

Is There a Better Alternative for Pakistan?

1. Hybrid Monetary Policy

1. Combine inflation targeting with growth objectives.
2. Example: India’s flexible inflation targeting (4% ± 2%)

2. Strengthen Fiscal Reforms

1. Reduce deficit: Cut wasteful subsidies, expand tax net.
2. Debt management: Limit borrowing from SBP.

3. Address Supply-Side Inflation

1. Boost Agriculture production: Invest in agriculture to increase domestic production and reduce agriculture imports.
2. Invest in Energy sector: BOOST energy sector to overcome energy crisis make renewable energy that will lead to pump in domestic production and will also reduce circular debt

Conclusion:

Inflation targeting in Pakistan has grappled with external shocks, fiscal mismanagement, and structural vulnerabilities. While conventional instruments such as interest rate increases and exchange rate depreciation have been used aggressively, they’ve not managed to rein in inflation without suffocating growth.

Key Takeways

1.  Rate hikes in isolation cannot cure supply-side inflation.
2. Fiscal discipline is necessary for inflation targeting in Pakistan to be functional.
3. A combination approach (growth + inflation control) could be superior.
4. Without more profound changes, inflation targeting in Pakistan. It has a risk of turning into yet another well-meaning but failed policy in a series of economic disappointments.