Why Did Pakistan's Inflation Reach a 50-Year High?

FY23 Inflation: The Numbers

Pakistan's headline consumer price inflation averaged 29.2% in fiscal year 2023 (July 2022 to June 2023), according to World Bank estimates based on Pakistan Bureau of Statistics data.^[1] This marked the highest annual inflation rate since FY74, when global oil shocks pushed prices up across developing economies.

The surge was not gradual. Monthly inflation climbed from around 20% at the start of FY23 to a peak of 38% year-on-year in May 2023.^[1] By the fiscal year's end, inflation had moderated slightly to 27.4% in August 2023, largely due to base effects rather than genuine price stability.

To put this in perspective: inflation in FY22 had been 12.2%.^[1] In a single year, the rate more than doubled.

How Does This Compare Regionally?

Pakistan's inflation crisis stood out even in a region grappling with global price pressures. Using calendar year 2023 data from the World Bank:^[2]

Sri Lanka, which experienced a severe economic crisis in 2022 with inflation reaching nearly 50%, had already begun stabilizing by 2023. Pakistan's inflation, by contrast, was still accelerating.

What Drove Inflation?

Three forces converged to push prices to historic highs: supply shocks from the 2022 floods, administered energy price increases, and currency depreciation. But behind these proximate causes lay a deeper structural problem: the government's fiscal position forced monetary policy into an impossible contradiction.

Food: The Floods and Their Aftermath

Food inflation was the single largest contributor to headline inflation. In rural areas, where most of Pakistan's poor live, food prices rose by 40.8% in FY23—more than triple the 13.0% rate in FY22.^[1] Urban food inflation reached 37.3%.

The 2022 floods, which submerged roughly one-third of Pakistan's land area at their peak, destroyed an estimated 4.4 million acres of crops.^[1] Grain storage facilities were damaged, and the subsequent wheat planting season was delayed as floodwaters receded slowly from agricultural land.

As domestic supply contracted, Pakistan became more reliant on food imports. Wheat imports increased by 23.7% year-on-year, soybean oil by 58.4%, and pulses by 48.3%.^[1] But with the rupee depreciating by 28.6% against the dollar over the fiscal year, these imports became substantially more expensive.

Energy: Tariff Adjustments and Fuel Levies

Energy prices rose by approximately 40% in both urban and rural areas in FY23.^[1] This was partly by design.

The petroleum development levy (PDL), which had been set to zero during the previous government's fuel subsidy program, was increased to PKR 50 per liter by November 2022. Even as global oil prices eased from an average of $89.2 per barrel in FY22 to $84.3 in FY23, the weaker rupee and higher taxes kept domestic fuel prices elevated.

Electricity tariffs were adjusted multiple times through the year as part of commitments under the IMF program. Gas prices increased by an average of 75%.^[1] These adjustments were necessary to reduce energy sector losses, but their timing amplified price pressures.

The Exchange Rate

The Pakistani rupee depreciated by 28.6% against the US dollar between July 2022 and June 2023.^[1] For an economy dependent on imported fuel, food, and industrial inputs, this translated directly into higher domestic prices.

The Monetary Policy Paradox

The most striking feature of Pakistan's FY23 inflation episode was not the scale of price increases—though that was historic—but the apparent contradiction at the heart of monetary policy.

Pressing the Brake and Accelerator

The State Bank of Pakistan (SBP) responded to rising inflation by raising the policy rate aggressively. Between the start and end of FY23, the rate increased by a cumulative 825 basis points to reach 22%—the highest in Pakistan's history.^[3]

Under normal circumstances, higher interest rates should slow inflation by making borrowing more expensive, reducing demand, and strengthening the currency. But in FY23, monetary tightening appeared to have limited effect. Why?

The answer lies in how the government financed its deficit. With access to external capital markets effectively closed—Pakistan's sovereign credit ratings had been downgraded, and investor confidence was severely impaired—the government turned to domestic banks for financing. Government borrowing from commercial banks increased by 76.4% in FY23.^[1]

Banks, in turn, relied on liquidity injected by the SBP through Open Market Operations (OMOs) to meet the government's financing needs. The stock of outstanding OMOs more than doubled during FY23.^[1]

The result was rapid growth in the monetary base even as the policy rate climbed. Reserve money grew by 23% in FY23, and currency in circulation expanded by 21%.^[1] Money supply (M2) grew by 14.2%—higher than the 13.6% growth in FY22, when real GDP had expanded by 6.1%.

Why This Mattered

The World Bank described this situation as "pressing the brake and accelerator at the same time."^[1]

Higher policy rates increased government borrowing costs, which drove higher financing needs. These financing needs were met through increased borrowing from the domestic banking system, which necessitated increasing liquidity injections through OMOs. The monetary tightening thus undermined itself.

The report concluded that "the only sustainable solution is therefore to reduce the Government's primary deficit, reducing financing needs and borrowing from the domestic banking sector."^[1]

How Did Inflation Affect Households?

Aggregate inflation figures obscure significant variation in how price increases affected different groups. For Pakistan's poorest households, the inflation experience was substantially worse than the headline numbers suggest.

The Poor Faced Higher Inflation

The World Bank estimated that households in the poorest income decile experienced inflation rates roughly 7 percentage points higher than the richest decile.^[1] This disparity reflects differences in consumption patterns: poor households spend a larger share of their budgets on food and energy—precisely the categories with the steepest price increases.

Rising Poverty

The poverty headcount using the lower-middle-income poverty line ($3.65/day, 2017 PPP) is projected to have reached 39.4% in FY23—more than 5 percentage points higher than in FY22.^[1]

This increase reflected not only inflation's erosion of purchasing power but also the broader economic contraction. Real GDP declined by 0.6% in FY23, labor markets weakened, and the real value of remittances from overseas workers fell.

Social Protection Response

The government expanded its flagship social protection program, the Benazir Income Support Programme (BISP). Beneficiary households increased from 7.7 million in FY22 to 9.0 million in FY23, and the cash transfer amount was increased by 25% effective January 2023.^[1]

However, the World Bank assessment concluded that "these increased transfers were not sufficient to compensate for the significant increase in the cost of living."^[1]