Rising money supply puts export competitiveness at risk

ISLAMABAD: Pakistan’s export sector continues to struggle despite repeated currency depreciations, IMF-backed stabilisation and periodic policy support. Merchandise exports have remained largely within the $28–32 billion range over the past four years. After reaching $32.1 billion in FY2025, exports fell 6.8% to $30.13 billion in FY2026, underscoring the economy’s inability to convert macroeconomic stability into sustained export growth.

Common explanations include low productivity, limited value addition, unreliable energy supplies, high logistics costs and weak global marketing. However, one often-overlooked factor is the rapid expansion of broad money (M2). Excess liquidity fuels inflation, raises production costs, weakens the benefits of currency depreciation and shifts business incentives toward domestic sales rather than exports.

M2 growing faster than the economy

Pakistan’s broad money (M2) increased from about Rs40.5 trillion in June 2025 to Rs46.2 trillion by June 2026, an increase of nearly Rs5.7 trillion in one year. This growth significantly outpaced nominal economic expansion, creating excess liquidity in the economy. The increase was driven by fiscal borrowing, private-sector credit growth and remittance-supported bank deposits.

At the same time, currency circulating outside the banking system rose from around Rs10.6 trillion in FY2025 to nearly Rs11.9 trillion in FY2026. Much of this cash is believed to circulate through undocumented commodity trade, speculative hoarding and informal financial transactions involving wheat, rice, sugar, edible oil, yarn and precious metals. Such cash-based activity weakens financial intermediation, encourages tax evasion and reduces the effectiveness of monetary policy. When money supply expands faster than output, inflationary pressures inevitably build.

Inflation erodes export competitiveness

Although inflation has eased from earlier peaks, it remains elevated. Consumer prices rose 11.1% year-on-year in June 2026, while average inflation during July–May FY2026 stood at around 6.7%. Economic research consistently links excessive money supply growth with higher inflation. Rising prices increase the cost of energy, wages, transport, imported inputs and financing, forcing exporters either to absorb higher costs or pass them on to overseas buyers, reducing competitiveness.

The often-cited “high cost of doing business” is therefore not driven solely by taxes, regulation or infrastructure gaps. Expansionary monetary conditions also play a major role. Meanwhile, the State Bank’s 11.5% policy rate, aimed at containing inflation, raises borrowing and working-capital costs, leaving Pakistani exporters at a disadvantage against regional competitors.

Why currency depreciation has limited impact

Successive governments have relied on rupee depreciation to boost exports. While a weaker currency should make exports more competitive, rapid monetary expansion often erodes those gains as domestic prices rise.

Higher import costs for fuel, machinery and industrial inputs further increase production expenses. Since Pakistan’s export sector depends heavily on imported raw materials, depreciation often results in imported inflation rather than stronger export growth. Exchange-rate volatility also discourages long-term investment and technological upgrading.

Excess liquidity favours domestic markets

Strong liquidity also boosts domestic demand, making local sales more attractive than exports, where firms face stricter quality standards, delayed payments and lower margins. At the same time, heavy government borrowing crowds out private investment, limiting access to affordable financing for exporters seeking to expand or modernise.

Monetary discipline should support export policy

Pakistan has significant export potential in textiles, agriculture, pharmaceuticals, engineering goods and IT services. Realising that potential requires treating monetary stability as a core element of export policy.

Broad money growth should remain aligned with economic growth and the State Bank’s medium-term inflation target of 5–7%. Fiscal and monetary policies must work together to reduce inflationary pressures, while exchange-rate management should prioritise a stable and competitive real exchange rate rather than repeated nominal devaluations.

Structural reforms—including higher productivity, greater value addition, lower energy costs and improved technology—remain equally important. Without monetary discipline, however, even well-designed reforms and export incentives are unlikely to deliver sustained export growth.

Pakistan’s export weakness reflects not only structural challenges but also years of money supply growth that has outpaced productive capacity. Unless inflation is brought under control, repeated devaluations and subsidy programmes such as the Drawback of Local Taxes and Levies (DLTL) are unlikely to produce lasting gains in exports or external-sector stability.