Pakistan and IMF: A universal cure for all diseases

The International Monetary Fund (IMF) staff and Pakistan reached a staff-level agreement on the fourth review of the $7-billion Extended Fund Facility (EFF) and the third review of the Resilience and Sustainability Facility (RSF) last week. The staff-level agreement is subject to approval by the IMF Executive Board. As it approaches, the language is already familiar.

Maintain a tight monetary policy. Preserve exchange-rate flexibility. Deliver the required primary surplus. Continue reforms to make energy prices reflect costs.

These are not new instructions. They are variations of the same four prescriptions Pakistan has encountered repeatedly in moments of economic distress: monetary tightening, fiscal consolidation, a market-determined exchange rate, and increases in energy prices.

Pakistan has spent decades periodically stabilising itself only to discover that the process of stabilisation has done little to increase the productive capacity necessary to prevent the next crisis.

Indeed, even during its May 2026 visit, the IMF reiterated the need for an “appropriately tight” monetary stance, exchange-rate flexibility and continued fiscal consolidation, alongside further energy-sector reforms.

The latest review could provide an opportunity to ask a question that is usually avoided in the rush to meet the next performance criterion: are these policies actually designed for the kind of inflation and economic structure Pakistan has?

The IMF stabilisation programme has worked in one important sense. Pakistan avoided default. Foreign-exchange reserves recovered. The exchange market stabilised. Inflation eventually came down. The country moved away from the precipice it faced in 2023.

But stabilisation and development are two very different things. Pakistan has spent decades periodically stabilising itself only to discover that the process of stabilisation has done little to increase the productive capacity necessary to prevent the next crisis. The economy grows, runs into an external constraint, slows down, returns to the Fund, compresses demand, stabilises and begins the cycle again.

It is the economic equivalent of prescribing the same paracetamol every time the patient returns with a fever without asking why the fever keeps returning. The intellectual roots of this approach lie in the broader Washington Consensus tradition: fiscal discipline, liberalised markets, competitive exchange rates, privatisation and the belief that correcting macroeconomic prices and incentives creates the foundations for growth. There is logic behind much of it. A government cannot indefinitely spend money it does not have. An exchange rate cannot permanently be defended at an artificial level. Loss-making energy systems cannot endlessly accumulate liabilities.

The problem begins when stabilisation orthodoxy becomes a substitute for diagnosis. Consider monetary policy. The textbook justification for increasing interest rates is straightforward. When an economy is overheating because households and businesses are spending too much, raising the cost of borrowing discourages consumption and investment. Aggregate demand falls. Price pressures moderate. But this mechanism assumes that excess demand is an important source of the inflation being treated.

Pakistan’s inflationary episodes repeatedly contain large supply-side components: international commodity prices, imported fuel, food shortages, administered electricity and gas prices, taxation and exchange-rate depreciation.

The State Bank’s own research illustrates this. Its examination of inflation dynamics found that supply shocks accounted for 48% of changes in inflation between 1992 and 2011, while real-demand shocks accounted for only 10%. More recent SBP research identifies global commodity prices, the money supply and fiscal policy among the major historical drivers, with the exchange rate also exerting significant effects during certain periods.

In other words, Pakistan’s inflation is not exclusively a monetary phenomenon, nor is it exclusively supply-driven. But treating every inflationary episode as though excessive domestic demand were its central cause is equally indefensible.

The experience of 2023-24 is particularly instructive. Pakistan entered FY24 with the policy rate at 22%. It remained extraordinarily restrictive for almost the entire fiscal year. Yet average inflation during FY24 was still 23.4%.

Why? The State Bank itself says that substantial increases in administered food and energy prices, exchange-rate depreciation and higher taxes and levies added to inflation during the first half of the year. It notes explicitly that these developments partly neutralised the effects of policy-induced weakness in domestic demand. Energy inflation reached a multi-decade high; the increase in gas prices alone contributed roughly one-fifth of urban headline inflation during FY24.

That is an extraordinary policy contradiction. Demand was already being suppressed by some of the highest interest rates in Pakistan’s history, while other components of the adjustment programme were simultaneously raising electricity, gas and other costs.

The response is usually “second-round effects”. There is a legitimate economic argument here. A central bank cannot produce oil, wheat or electricity, but it can attempt to prevent an initial supply shock from becoming embedded in expectations and spreading into wages and other prices. But second-round effects cannot become an all-purpose justification for monetary tightening regardless of the original source of inflation.

If electricity becomes expensive because tariffs have been raised, increasing the interest rate does not produce cheaper electricity. If imported fuel becomes expensive because the rupee depreciates, a higher interest rate does not increase Pakistan’s domestic oil supply. If flour becomes expensive because of a wheat shortage, making working capital more expensive for businesses does not grow wheat. It suppresses something else: economic activity.

There is also longstanding evidence that Pakistan’s monetary transmission mechanism does not behave like that of the advanced economies from which much conventional monetary theory is derived. A 2015 study by Ehsan Choudhri, Asad Jan and Hamza Malik found that conventional Vector Autoregressive (VAR) estimates showed monetary-policy shocks having an insignificant effect on both inflation and output in Pakistan, raising serious questions about the effectiveness of monetary transmission. Later SBP research found that transmission had improved, particularly through the credit channel, but that itself tells us something important: the effects of tighter monetary policy are transmitted substantially by restricting credit.

And restricting credit has a price. Businesses delay expansion. Working capital becomes more expensive. Investment becomes less attractive. Construction slows. Industrial capacity remains stagnant. Then we express surprise that Pakistan does not grow.

The same tension exists in fiscal policy. Pakistan unquestionably requires fiscal reform. A state with a chronically narrow tax base, persistent deficits and enormous debt-servicing obligations cannot continue indefinitely. The IMF is correct to demand fiscal sustainability.

But there is an enormous difference between structural fiscal reform and fiscal compression. The former expands the tax base, taxes undertaxed income and assets, reforms state-owned enterprises, reduces leakages and redirects expenditure toward productivity. The latter raises taxes wherever collection is easiest and suppresses spending sufficiently to produce the required primary balance.

Both may improve a spreadsheet. Only one transforms an economy. Fiscal consolidation imposed simultaneously with tight monetary policy can produce a vicious circle. Government spending is restrained while private investment is discouraged by expensive credit. Growth weakens. With weaker economic activity comes a smaller potential tax base, making future revenue mobilisation harder. Development expenditure is squeezed further, productive capacity grows more slowly, and the same fiscal weakness eventually reappears.

The growth cost is not merely theoretical. In April 2025, the World Bank noted that Pakistan’s economic growth remained weak amid continued tight macroeconomic policies, and projected that growth would remain constrained partly because tight monetary and fiscal policies were still required to rebuild buffers.

That is the fundamental bargain embedded in stabilisation: stability today in exchange for some growth today. Occasionally that bargain is necessary. In 2023 it almost certainly was. It should not become Pakistan’s permanent development model.

Then there is the exchange rate. Perhaps no number in Pakistan’s economic discussion is more misunderstood than the Real Effective Exchange Rate. The REER attempts to capture movements in the rupee against the currencies of Pakistan’s trading partners while adjusting for relative prices. Yet the number 100 has acquired an almost mystical significance in public debate, as if a REER of 100 represents economic equilibrium and anything above it proves that the rupee is overvalued. It does not.

The State Bank could hardly be clearer. Pakistan’s current series uses the average value in 2010 as 100. SBP explicitly warns that a REER of 100 should not be interpreted as an equilibrium exchange rate. Moving above or below 100 simply means the real effective exchange rate has changed relative to its 2010 average. Determining whether a currency is actually misaligned requires analysis of productivity, external sustainability, fiscal conditions, demographics and other fundamentals.

There was nothing divinely optimal about Pakistan’s economy in 2010. Therefore there is no economic law requiring the REER to return to 100. A market-determined exchange rate is one thing. Treating an arbitrary index base as a policy destination is another. This distinction matters enormously for Pakistan because depreciation itself can be inflationary. Pakistan imports fuel, machinery, industrial inputs and other necessities. When the rupee loses value, the domestic cost of those imports rises. The cost then travels through production chains until it reaches the consumer.

The supposed benefit is increased export competitiveness. But depreciation cannot create an export sector by itself. If an exporter imports machinery, chemicals, fuel or intermediate inputs, depreciation simultaneously raises production costs. And if Pakistan lacks productivity, infrastructure, reliable energy, access to finance and sophisticated products that global markets actually demand, making the rupee cheaper will not magically manufacture competitiveness. An exchange rate can alter relative prices. It cannot substitute for industrial policy.

And then comes the fourth prescription: energy prices. No serious observer can deny the dysfunction of Pakistan’s power sector. Circular debt, losses, theft, inefficient distribution companies, capacity payments and poor governance cannot simply be ignored. But repeatedly increasing tariffs to recover the cost of inefficiency is not the same thing as removing the inefficiency.

Again, FY24 demonstrates the contradiction beautifully. Energy tariff adjustments themselves contributed substantially to inflation. Monetary policy was then kept tight partly to bring that inflation under control. One arm of adjustment raised prices; another suppressed the economy to contain the consequences.

This may produce macroeconomic stability. It is difficult to call it an economic growth strategy. Which brings us to Pakistan’s supposedly excessive consumption. Every time growth returns, Pakistan’s recovery quickly becomes consumption-led. Imports rise, external pressures emerge and policymakers conclude that Pakistanis simply consume too much and save too little. But perhaps we should ask why they consume so much of what they earn.

The State Bank’s 2024-25 analysis of household saving provides a rather obvious answer: income. Its analysis found households in the lowest income quartile to be dissavers on average. Higher-income households saved dramatically more. SBP also noted that Pakistani per-capita income has lagged peers and that wage growth in recent years had failed to keep pace with inflation, concluding that without reversing those trends, the prospects for household savings remain dim.

The latest household data makes the point even more starkly. Pakistan Bureau of Statistics figures for 2024-25 put average monthly household income at Rs82,179 and average household consumption at Rs79,150. People cannot save income they do not have. For a household spending most of its earnings on food, rent, electricity, transport and education, consumption is not evidence of macroeconomic indiscipline. It is survival. Pakistan therefore returns to consumption-led growth partly because it has never built enough of the alternative: investment-led, productivity-led and export-led growth. And that is where the obsession with stabilisation becomes self-defeating.

Suppress investment for long enough and there is little new productive capacity. Compress development expenditure for long enough and infrastructure deteriorates. Make energy prohibitively expensive and industry loses competitiveness. Allow repeated depreciation without productivity growth and imported inflation returns. Keep household incomes low and savings remain low.

Then, when restrictions are eventually relaxed, what is left to drive growth? Consumption. Pakistan’s tragedy is not that the IMF’s four prescriptions never work. They often do precisely what they are designed to do. They stabilise. The rupee stops falling. Reserves rise. the current account improves. Inflation eventually moderates. Fiscal numbers look healthier. The immediate crisis passes. But stability achieved through repeated compression is not development. Three years after the desperate programme of 2023, Pakistan has rebuilt reserves and regained a measure of macroeconomic stability. Yet provisional growth for FY26 was only 3.7%. And inflation, after falling dramatically, returned to 11.1% year-on-year in August 2026.

The patient is stable. The patient is not healthy.

As Pakistan enters another IMF review, therefore, the debate should not simply be about whether the government has met another fiscal target or whether monetary policy is sufficiently tight. It should be about whether we are once again confusing the treatment of a crisis with the treatment of the economy.

Pakistan needed the IMF in 2023. It may need the IMF today. But after decades of returning to the same institution, implementing variations of the same stabilisation package and emerging with the same structural weaknesses, Pakistan has earned the right to ask whether the prescription itself needs to become more sensitive to the patient.

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