Pakistan's persistent inflation problem cannot be resolved through interest rate adjustments alone, according to a recent economic analysis that compares the country's monetary system with China's. The study, cited by The Express Tribune, argues that the root cause lies in how credit is allocated within the economy — not in the pace of money supply growth.

The Pakistan-China Divergence

Both Pakistan and China have expanded their broad money supply (M2) significantly in recent years, yet their inflationary outcomes have diverged sharply. Pakistan's headline inflation hovered around 11 per cent in 2026, while China recorded inflation of roughly 1 per cent over the same period — despite broadly comparable M2 growth rates. According to the analysis, this gap is not a coincidence of scale; it reflects a structural difference in where newly created money flows.

How Credit Allocation Drives Inflation

The analysis explains that inflation emerges when money supply expands faster than an economy's capacity to produce goods and services. When fresh liquidity is directed toward expanding productive capacity — through manufacturing, infrastructure, and exports — supply keeps pace with demand and price pressures remain contained.

China's state-directed banking system channels a large share of credit toward businesses, state-owned enterprises, and infrastructure projects. Banking regulators steer lending into sectors that expand industrial capacity, while a high household savings rate suppresses the velocity of money, limiting consumer-driven price increases.

Pakistan's Fiscal Deficit Problem

In contrast, Pakistan's banking system directs much of its additional liquidity toward financing the government's fiscal deficit. Banks have increasingly invested in Treasury Bills and Pakistan Investment Bonds, which fund debt servicing, subsidies, and public sector salaries rather than productive investments that could expand industrial output or export capacity.

The analysis argues this pattern injects demand into the economy without a corresponding increase in supply — creating the structural conditions for persistent inflation. Government wage bills and consumption by higher-income households become major demand drivers, while weak private investment limits productivity growth and job creation.

Crowding Out Private Investment

Government borrowing, the study contends, crowds out private sector credit, leaving businesses with fewer financing options and slowing both investment and hiring. Private sector wages consequently remain subdued even as inflation erodes purchasing power.

Notably, repeated pay revisions for government employees — financed through the federal budget — have reportedly widened the income gap between public sector workers and those in the largely informal private economy. This divergence compounds the inflationary pressure by boosting consumption among a segment insulated from market wages.

What This Means for Policy

The analysis implies that rate hikes by the State Bank of Pakistan can only address the symptom, not the cause. Without redirecting credit flows toward productive sectors and curbing government borrowing from commercial banks, monetary tightening risks slowing growth without meaningfully reducing inflation. Structural reform of credit allocation — rather than the blunt instrument of interest rate policy — is presented as the more durable fix. Whether Pakistan's fiscal constraints allow for such a pivot remains an open question.