A GLOBAL recession is on the cards and Pakistan is in the thick of it. Inflation in Pakistan was at an alarmingly 21.3 per cent in June, but going forward it needs to be wary of the ominous developments taking place elsewhere.

Inflation rates across the United States and the United Kingdom have soared past 9pc as per the latest figures. This shows that developing countries are not alone in their struggle to stay afloat, the economic powerhouses, too, are finding it hard to cope with supply chain disruptions in the wake of Russia’s military intervention in Ukraine.

With oil supplies dipping and energy prices soaring, a recession is the likely outcome. However, calling it a recession is merely a way of downplaying the imminent economic calamity. Recessions are treatable and monetary instruments are put in place to prevent the recessionary effects from getting out of hand.

What we are strolling into is way more dangerous than a recession; it is a phenomenon called stagflation, which entails rising prices accompanied with prolonged period of decreasing gross domestic product (GDP) growth and high unemployment. Experts call it an economic anomaly.

According to the Pakistan Economic Survey 2021-22, Pakistan posted a GDP growth of 5.97pc as the effects of Covid subsided. Although it was a remarkable achievement in itself, the inflation shot up due to an overheated domestic economy. Increased growth rates spurred higher spending and subsequently lower unemployment ratios.

The combination of both expansionary fiscal and monetary policies drove Pakistan into a state of demand-pull inflation. As the supply diminished and inflation rose drastically, firms laid off their workers and growth rates deteriorated as a result. The State Bank of Pakistan (SBP) hiked interest rates and tightened money supply, while the government initiated contractionary policies to counter inflation.

Normally, such contractionary measures reduce the overall consumer spending, which, in turn, stabilises inflation rates and the economy slows down, causing a recession. However, the notion of a recession failed to gain traction as inflation should have been stopped in its tracks in the context of the conventional boom-bust cycle.

Instead, Pakistan is witnessing an unrelenting tide of high inflation amid decreased growth levels which evidently corroborates the existence of stagflation in Pakistan. The dependence on imports places Pakistan at the epicentre of stagflation and leaves us particularly vulnerable to the antagonism of cost-push inflation.

As mentioned, there are several remedies to cure a recession as the government can encourage spending or introduce tax cuts, while SBP can stimulate the economy by lowering interest rates and increasing money supply. But there is hardly any effective way to deal with stagflation because it pushes all the key economic indicators, like growth, inflation and unemployment, in the wrong direction. Correcting one makes the others even worse, which is not the case with recession management.

The government cannot raise wages in times of stagflation, fearing it will lead to more inflation or ultimately lower purchasing power. Inflation expectations and stagnant wages, on the other hand, will discourage spending and the growth rates will fall. The SBP cannot lower interest rates because there will be no deterrence to high inflation. Also, it cannot hike interest rates as GDP/output will further sink as a result.

Usually, inflation and unemployment rates have an inverse relation, as illustrated by the widely popular Phillips Curve. However, stagflation contradicts the theory by emphasising that inflation moves parallel to unemployment. Moreover, the unemployed workers cannot be given grants or targeted subsidies considering it will result in more consumer spending and, hence, inflation.

So, the unemployment ratios remain dangerously high and output inadvertently low. Similarly, tax incentives and aggressive spending by the government would increase growth, on the one hand, and aggravate inflation, on the other.

For Pakistan, stagflation is relatively a newer term, although it rose to prominence back in the 1970s when oil embargo by the Organisation of the Petroleum Exporting Countries (Opec) against Western nations and the Iranian revolution caused huge supply shortages and sent oil prices soaring. It took almost a decade worth of toil for the US to escape from the shackles of stagflation. The delay was owing to the flurry of flawed economic practices carried out daftly during that period.

Pakistan must learn from the economic casualties of the past and refrain from devising short-term policies to overlook the gravity of stagflation for the purpose of gaining political mileage.

Inflation targeting by SBP, and the efficient allocation of labour are some temporary solutions. Resumption of oil production to pre-Ukraine conflict levels, which seems like a distant possibility at this point of time, will eventually get us out of this stagflation quicksand, one hopes.

Muhammad Taimur Khan
Islamabad

Published in Dawn, August 8th, 2022

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