High Interest Rates: Tackling supply-driven inflation in Pakistan

Pakistan’s inflation is no longer driven solely by excess demand. Yet the policy response continues to rely heavily on high interest rates the classic tool for curbing demand.

On April 27, 2026, the State Bank of Pakistan raised its policy rate by 100 basis points to 11.5%, the first hike in nearly three years. This followed headline inflation rising to 7.3% in March 2026 (from 7.0% in February), breaching the 5–7% target range.

The uptick has been driven largely by energy costs, transport expenses, currency pressures, and supply constraints, including volatility in global fuel prices linked to regional tensions. Inflation had earlier fallen sharply from a peak of 38% in May 2023 to as low as 0.3% in April 2025 before rebounding.

When inflation stems primarily from supply-side factors higher production and transport costs, imported input dependence, and bottlenecks raising borrowing costs does not directly address the root causes. It mainly compresses economic activity.

Businesses, especially smaller firms and SMEs, face elevated financing expenses, leading to delayed investments, slower hiring, and constrained private credit growth. Consumers, already strained by higher prices, cut back further. This dynamic sharpens the short-term Phillips curve trade-off: lower inflation at the cost of softer growth and higher unemployment risks.

Recent economic performance shows GDP growth at around 3.6–3.9% in the first half of FY26, with large-scale manufacturing recovering modestly (around 4.8–5.7% in some periods). However, sustained high real rates risk weighing on this modest recovery.

A more balanced approach

Fiscal and trade policies can target underlying cost pressures more precisely than broad monetary tightening:

• Targeted relief on fuel and energy (through adjusted taxes or well-designed subsidies) to lower transportation and production costs, with ripple benefits for food and essential goods.
• Public investment in storage facilities, logistics, and agricultural supply chains to reduce post-harvest losses and price volatility.
• Calibrated trade measures, such as lowering tariffs on key imported inputs, to ease supply shortages in an import-dependent economy.

These measures carry risks, including budget pressures and potential inefficiencies if poorly targeted. Yet they offer a more direct response to cost-push inflation than across-the-board demand suppression. Well-designed fiscal and supply-side actions can complement monetary policy rather than work against it.

The central bank still plays a vital role in anchoring inflation expectations and maintaining overall stability. However, when elevated interest rates become the dominant response despite clear supply-driven drivers the economy can bear unnecessary costs in lost growth and investment.

Controlling inflation remains essential, but the method matters greatly in Pakistan’s context of structural bottlenecks and external vulnerabilities. A more coordinated strategy, combining monetary prudence with targeted fiscal and supply-side measures that better reflect ground realities, offers a stronger path to reducing prices while supporting sustainable growth. The question is not whether to fight inflation, but how intelligently.