The dark side of disinflation

“If the price of everything is going down, that’s going to include wages as well. People will have an incentive to sit on their cash and not spend it.” – Paul Krugman

Krugman’s quote instantly came to mind while reading recent headlines. Our Prime Minister regarded the recent disinflation on the completion of the government’s first year as “very good news”, and for the right reasons.

After all, the economy does seem to be stabilizing at first glance. Inflation has dropped to 1.5 percent, down from 38 percent in mid-2023. Interest rates still stand at 12 percent, and exports for the first eight months of FY25 have grown by 8.17 percent to US$ 22.02 billion. These numbers do testify to a stabilizing rupee and improved exports, all just in time to secure the much-awaited second $1 billion tranche from the IMF.

But as they say, the devil is in the details. While inflation is slowing, Pakistan treads on a bumpy economic road. High inflation persists in non-food sectors, such as housing, healthcare, and construction wages.

Exports declined by 5.5 percent to US$ 2.44 billion in February, widening the trade deficit by 33.43 percent to US$ 2.29 billion.

Furthermore, unemployment has increased from 4.5 million to 18.7 million, meaning that 22 percent of the workforce is now jobless. These figures indicate that stability is coming at the unbearable cost of stagnated growth.

This is the dark side of disinflation, as pointed out by neo-Keynesian economists. If prices are falling due to decreased spending, it is not a sign of economic strength but of stagnation. In Pakistan’s case, disinflation can be attributed to shrinking demand, rising costs, and policy uncertainty.

Although it is “very good news” that the prices of goods and commodities are falling, the unemployment and export figures don’t align.

The textile industry has performed better this year, but with 60 percent of total national exports coming from this sector, we must address its ongoing challenges. This year has seen the second-lowest level of domestic cotton production in the country’s history; output has fallen 50 percent below the official target and 34% below last year’s target, as stated in the Pakistan Cotton Ginners Association’s report.

The fall in domestic cotton further increases reliance on imports, which are exempt from sales tax under the EFS, while local cotton faces an 18% sales tax. Additionally, there has been an upward revision in gas tariffs for captive power plants (CPPs) along with a phased 20 percent levy on the supply of natural gas to the textile industry — the effects of which will hit the industry hard.

Another major factor hurting the competitiveness of exports is high energy costs. According to the International Energy Agency (IEA) ‘Electricity 2025 — Analysis & Forecast to 2027’ report, Pakistan’s industrial electricity rates stood at 13.5 cents/kWh in 2024 — almost double that of India (6.3 cents/kWh) and significantly higher than China (7.7 cents/kWh) and even the European Union (11.5 cents/kWh).

While certain export sectors such as cement (34.3% growth) and IT services (24% growth) have shown promise, further policy reforms are needed to expand exports. Energy-intensive industries such as textiles, steel, and cement cannot remain globally competitive, as higher energy costs shrink profits.

Countries like Bangladesh, China, and Vietnam, with lower electricity rates and better policy incentives, have already lured international buyers away from Pakistan.

The bigger concern is that Pakistan’s declining exports in key sectors signal a long-term challenge rather than a temporary fluctuation. When global buyers shift their sourcing to more cost-effective countries, it becomes difficult to regain lost market share.

The interest rate cut to 12 percent from 22 percent (April 2024), was impressive, but keeping it at 12 percent as of 10th March, makes it still too high for businesses to expand and grow. Although high interest rates have been justifiable in controlling the devaluation of the rupee and inflation, further policy revisions are needed.

The dire economic situation mirrors Japan’s Lost Decade of the 1990s, where efforts to control inflation led to stagnation. Businesses hoarded cash, wages stagnated, and economic expansion slowed. If inflation in Pakistan continues dropping but investment and job creation remain weak, the country risks entering a phase of prolonged low growth, where economic recovery becomes sluggish and uncertain.

Small and medium-sized enterprises (SMEs), which form the backbone of Pakistan’s job market, continue to face credit shortages and policy instability, preventing them from playing a meaningful role in economic recovery. Without strong domestic investment, export-driven sectors alone will not be enough to sustain long-term growth.

The IMF’s financial oversight ensures Pakistan remains fiscally disciplined but limits the government’s ability to pursue aggressive industrial expansion. While fiscal consolidation is necessary, it should not come at the cost of economic competitiveness.

The newly-formed Tax Policy Office (TPO) must align IMF requirements with economic realities; ensuring exporters receive breathing space through tax rationalization and competitive energy pricing.

The current 29% corporate tax and multiple surcharges have led to an effective tax rate exceeding 158 percent of profits for some exporters, a burden that stifles industrial expansion.

Instead of incentivizing businesses to invest, hire, and expand, the tax burden discourages entrepreneurship and limits the economy’s ability to generate employment.

Pakistan cannot afford austerity-driven stagnation. Stability alone is not success. Not planning is planning to fail. Without economic policies creating a friendly environment for exporters and businesses in general, Pakistan faces the risk of prolonged slowdown. The February export decline should not be dismissed as something temporary; it is a warning about the consequences of inaction.

Decisive steps such as revision of energy tariffs, tax relief, and easy access to credit for critical businesses should be considered to boost our exports and create a breathing space for domestic businesses. Given the dire economic situation, special economic zones should be created, where offering interest rate windows to export-driven sectors to enhance competitiveness and drive sustainable growth.

Without these steps, Pakistan risks repeating the mistakes of economies that mistook short-term stability for long-term prosperity, instigating eventual bankruptcy. If the government continues prioritizing financial targets over real economic expansion, businesses will remain hesitant, workers will continue to struggle with job losses, and export performance will deteriorate further.

The IMF’s presence should not dictate an economic slowdown—it should facilitate reform that enables long-term growth. Pakistan’s policymakers have a narrow window of opportunity to take bold actions that stimulate industry, employment, and trade expansion. If they fail to act, the dark side of disinflation will not just be a temporary phase but a long-term economic reality.

Copyright Business Recorder, 2025