Zafar Iqbal

Pakistan’s inflation story has taken a significant turn in recent months, with headline inflation plummeting to a modest 2.4% in December 2024. This marks the lowest inflation rate since October 2015 and is a sharp drop from the 28.3% recorded in the same month last year. While this decline certainly indicates a positive trend, a deeper look into the underlying factors reveals that the relief for everyday consumers is more nuanced and far from guaranteed.

The Decline in Inflation: What’s Behind It?

A considerable portion of the drop in inflation can be attributed to the high base effect from 2023, which saw an enormous surge in prices due to the global commodity supercycle and Pakistan’s currency depreciation. This high base is skewing current comparisons, making the year-on-year inflation appear significantly lower than it was during the peak of the inflation crisis.

Additionally, inflation has been easing due to a more controlled economic environment. The fiscal and monetary tightening policies implemented by Pakistan’s government and central bank in 2024 have contributed to slowing inflationary pressures. Last year, loose fiscal policies and strong domestic demand stoked inflation, but this has now been curbed by higher interest rates and a reduction in government spending.

Energy prices, especially electricity and fuel, have been major contributors to the inflationary spike in 2022 and 2023. These sectors saw price increases due to rising global oil and hydrocarbon prices. However, over the past 12 months, these prices have decreased by 15.6% for electricity and 2.5% for fuel, providing some relief to consumers.

The largest drop in inflation has been observed in food prices, which saw a year-on-year decline of 3.1%. Specifically, perishables like vegetables, fruits, and meat have seen notable decreases, with items like wheat products (including roti) and eggs experiencing significant price drops. These reductions in food prices are a welcome change after the food price hikes that were a key driver of inflation in 2022 and 2023.

However, Relief Is Not Universal

Despite the headline drop, the reality is more complicated, especially for segments of the population that do not benefit from the fall in food and energy prices. For example, the costs of clothing, footwear, healthcare, education, and various miscellaneous items continue to rise at double-digit rates. These sectors, which account for about 20% of the overall Consumer Price Index (CPI), disproportionately impact middle-class and salaried individuals who are already stretched thin due to high living costs. While lower food and energy costs may ease the strain on urban dwellers to some extent, many continue to face financial difficulties due to rising non-food, non-energy costs.

Moreover, the situation is even more challenging for rural communities, where core inflation remains high, and farm incomes are under pressure. Core inflation, which excludes volatile food and energy prices, has also decreased but remains sticky compared to the broader inflation trend. In January 2025, core inflation stood at 8.8%, a sharp decline from 20.5% in the same period the previous year. However, this reduction has been gradual and insufficient for many sectors of the economy, especially in rural areas.

The Flipside: What Lies Ahead?

While it may seem that inflation is now under control, a number of economic factors indicate that this could be temporary. One key factor to consider is the upcoming Ramadan and Eid seasons. These periods traditionally see a significant uptick in demand for food, particularly perishables, which could lead to higher food prices. As a result, the current trend of falling food prices could reverse, pushing inflation up again in the near future.

Another potential driver of inflation is the wage-price spiral. As the economy stabilizes, workers are likely to demand higher wages to match the rising cost of living. If these wage demands are met, businesses may pass on the increased labor costs to consumers, pushing prices higher. This cycle of rising wages and increasing prices could further strain the economy if not managed properly.

The decline in interest rates—by a massive 1,000 basis points—could also fuel demand and contribute to inflationary pressures. With lower borrowing costs, consumer demand might pick up, potentially leading to an increase in prices. While this could stimulate economic growth, it might also reignite inflation if supply fails to keep up with rising demand.

Another significant factor to monitor is the movement of Pakistan’s currency. While the Pakistani rupee has remained stable for now, the country’s foreign trade dynamics may push the exchange rate higher. As economic activity picks up, imports may increase, putting pressure on the rupee. If the exchange rate weakens, the cost of imported goods and services could rise, exacerbating inflation.

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The Role of the Base Effect

Right now, the high base from 2023 is contributing significantly to the low inflation numbers for 2024. In essence, inflation is being compared to a period of exceptionally high prices, making the current figures seem more favorable than they truly are. As time passes and the base effect fades, inflation may start to climb again, even if global commodity prices and the exchange rate remain stable.

This base effect will likely reverse in the coming months, and as inflationary pressures from wages, energy prices, and domestic demand mount, inflation could begin to creep upward. It is crucial to remember that while headline inflation has fallen, the underlying pressures remain, and price levels may rise again when the base effect is no longer a factor.

The Need for Stable, Long-Term Inflation Control

Inflation is a complex issue that requires careful management to ensure long-term economic stability. While the recent drop in inflation is a positive sign, it is essential for Pakistan to focus on maintaining stable, single-digit inflation. A volatile inflation rate creates uncertainty and hampers long-term investment, both of which are crucial for sustained economic growth.

The government’s challenge will be to strike the right balance between stimulating growth and controlling inflation. Policymakers will need to implement measures that promote productivity and supply-side improvements, rather than relying solely on demand-side controls like high interest rates and tight fiscal policies.

Looking ahead, FY26 will likely be a critical year for Pakistan’s inflation trajectory. The country must take proactive steps to avoid a return to high inflation, which would undermine economic recovery efforts and exacerbate poverty levels. Implementing policies that address both inflation and growth, while improving the supply chain and enhancing domestic production, will be key to ensuring the long-term prosperity of the economy.

In conclusion, while Pakistan has made notable progress in curbing inflation, the battle is far from over. The economy remains vulnerable to a variety of internal and external pressures, and unless sustained structural reforms are implemented, inflation could rise again, leaving the country in a precarious economic position.