Pakistan is presently experiencing a never-before-seen economic crisis, marked by skyrocketing inflation rates and a devaluation of its currency. Experts are increasingly pointing to the unchecked expansion of the money supply as the cause of the current economic turmoil, as the government attempts to address it. In this article, we will examine how Pakistan’s current economic predicament was precipitated by the money supply dilemma.
At the core of Pakistan’s economic difficulties is the issue of the money supply, particularly the broad money supply, also known as M2. M2 includes all circulating money in an economy, including cash, deposits, and liquid assets held by non-bank financial institutions. Without a corresponding increase in commodities and foreign exchange, the increase in M2 has paved the way for inflation and currency devaluation.
The International Monetary Fund (IMF) had anticipated a rise in the broad money supply, but attributed it to infusions of foreign reserves as opposed to a rise in the local currency supply. By the end of 2021, however, the IMF had imposed restrictions on the government, prohibiting direct borrowing from the State Bank of Pakistan (SBP) to finance the deficit. The government found a way around this restriction by borrowing from commercial banks, which in turn received financing from the SBP, perpetuating the cycle.
Renowned Business and Economics Journalist Khurram Husain casts light on the situation. According to Husain, successive administrations, particularly in 2020 and 2021, employed an aggressive growth strategy by injecting significant funds into the economy. As a result of this unrestrained monetary expansion, Pakistan’s current economic situation is perilous.
Commercial institutions play a crucial role in this economic dilemma. The report titled “Pakistan Banking Sector – 2QCY23” by JS Global reveals that the Asset Deposit Ratio (ADR) for banks dropped below 50%, indicating a shift toward investments in government bonds financed by SBP OMO borrowings. This pattern illustrates the government’s excessive reliance on the SBP to finance its fiscal deficit.
To address this economic crisis, multiple measures are required. First and foremost, it is essential to limit government borrowing and reduce the asset allocation ratio of commercial banks progressively. To assimilate the excess money supply, banks should also prioritize lending to private depositors and non-bank financial institutions.
However, the government also bears a significant amount of culpability for the current situation. To effectively manage the budget deficit, the government must reduce expenditures and raise revenues. Implementing taxation in formerly untaxed industries, such as agriculture, and rationalizing expenditures are necessary measures. To ensure that substantial segments of the population contribute to the nation’s finances, a just tax system that distributes the burden across all economic sectors is required. In addition, reducing the public sector’s dominance and incentivizing banks to lend to the private sector are essential for sustained economic growth. Yousuf Farooq, Director of Research at Chase Securities, stresses the importance of an all-encompassing strategy. He proposes that the government address these problems by instituting taxation on untaxed sectors, rationalizing expenditures, and establishing a fair tax system. In addition, reducing the public sector’s dominance and encouraging banks to lend to the private sector are crucial for economic growth.
While the government seems intent on meeting IMF requirements and mitigating damage, the road to economic recovery remains long. Currency devaluation is a strategy for increasing exports and reducing trade deficits, but it must be accompanied by reforms in the energy, labor, and taxation sectors. The competitive advantage of low-cost labor and a concentration on labor-intensive manufacturing can assist Pakistan in overcoming its current economic obstacles and establishing a more robust and sustainable economy.
Pakistan’s economic crisis is a complex web of fiscal deficits, unchecked money supply expansion, and debt reliance. To find a solution, the government must employ a multifaceted strategy that includes reducing expenditures, increasing revenues, and promoting an equitable tax system, all while focusing on labor-intensive manufacturing to capitalize on its competitive advantage.
