Surging M2 undermines export competitiveness

Pakistan's export sector continues to underperform despite repeated currency depreciations, IMF-supported stabilisation and periodic policy interventions. Merchandise exports have largely remained between $28-32 billion over the past four years. Exports reached $32.1 billion in FY2025, but declined 6.8% to $30.13 billion in FY2026, highlighting the economy's inability to translate macroeconomic adjustments into sustained export growth.

Conventional explanations include low productivity, limited value addition, unreliable energy supplies, high logistics costs and weak global marketing. However, one critical factor receives far less attention: the rapid expansion of broad money (M2). Excessive monetary growth fuels inflation, raises production costs, erodes gains from currency depreciation and shifts incentives from exports towards domestic sales and consumption.

Monetary expansion outpacing economic growth

Pakistan's broad money (M2) expanded from approximately Rs40.5 trillion in June 2025 to around Rs46.2 trillion by June 2026, an increase of nearly Rs5.7 trillion in just one year. This expansion far exceeded the pace of nominal economic growth, creating a significant monetary overhang. The increase has been driven by fiscal financing requirements, domestic credit expansion and strong remittance inflows that boosted bank deposits. While each factor contributes differently, the result is the same: excess liquidity chasing limited productive capacity.

A worrying feature is the unusually large amount of currency circulating outside the banking system. Around Rs10.6 trillion remained outside banks in FY2025, rising to nearly Rs11.9 trillion in FY2026. A substantial proportion of this cash is reportedly used in undocumented commodity trading, speculative hoarding and informal financial arrangements involving wheat, rice, sugar, edible oil, yarn and precious metals. Such parallel cash-based transactions weaken financial intermediation, encourage tax evasion and reduce the effectiveness of monetary policy. When money supply expands faster than production, inflation becomes almost inevitable.

Inflation weakens export competitiveness

Pakistan's inflation has moderated from previous peaks but remains elevated. Consumer prices rose 11.1% year-on-year in June 2026, while average inflation during July-May FY2026 remained around 6.7%. Economic research consistently shows a strong long-term relationship between excessive money supply growth and inflation. Higher inflation raises the prices of energy, wages, transport, imported inputs and financing. Exporters in textiles, rice, leather garments and other traditional sectors are therefore forced to either absorb rising costs through lower profit margins or pass them on to overseas buyers, reducing their competitiveness.

The frequently cited "high cost of doing business" is therefore not solely the result of taxation, regulation or infrastructure deficiencies. Expansionary monetary conditions are an equally important contributor. The State Bank of Pakistan's policy rate of 11.5% reflects its continuing effort to contain inflationary pressures. While tight monetary policy helps stabilise expectations, it also increases borrowing costs, working capital requirements and trade finance expenses, placing exporters at a disadvantage against competitors in Bangladesh, Vietnam and India.

Why devaluation alone cannot deliver export growth

Successive governments have relied heavily on currency depreciation to improve export competitiveness. In theory, a weaker rupee should make Pakistani goods cheaper abroad. In practice, however, persistent monetary expansion quickly offsets these gains. As domestic prices rise following depreciation, the country's real exchange rate advantage gradually disappears.

Imported machinery, fuel and industrial raw materials become more expensive, pushing production costs even higher. Because Pakistan's export base remains narrow and dependent on imported inputs, devaluation often generates imported inflation rather than significant export expansion. Frequent exchange rate volatility also discourages long-term investment, export contracts and technological upgrading.

Excess liquidity encourages domestic sales

Abundant liquidity also strengthens domestic demand. Producers often find the local market more profitable and less risky than exports, where they face stringent quality standards, sanitary and phytosanitary requirements, delayed payments and thin margins. Large government borrowing further diverts financial resources from productive private investment.

Export-oriented firms seeking affordable financing for expansion, modernisation and technological upgrading often struggle to compete with government demand for credit. Consequently, productive investment remains below potential while export capacity expands only slowly.

Monetary stability must become export policy

Pakistan possesses considerable export potential through textiles, rice, agro products, pharmaceuticals, engineering goods and IT-enabled services. Unlocking this potential requires treating monetary stability as an essential element of export policy. First, M2 growth should be aligned more closely with real economic growth and the State Bank's medium-term inflation objective of 5-7%. Sustained price stability would eventually lower interest rates and reduce financing costs for exporters.

Second, monetary and fiscal policies must work together. Large fiscal deficits financed through domestic borrowing or monetary expansion perpetuate inflationary pressures. Greater fiscal discipline, improved tax collection and expenditure rationalisation would reduce pressure on the banking system and the central bank. Third, exchange rate management should aim for a competitive but stable real exchange rate rather than repeated nominal depreciations that quickly lose effectiveness through inflation.

Finally, monetary discipline must be accompanied by structural reforms. Higher productivity, technological upgrading, greater value addition, competitive energy pricing and lower tariffs on industrial inputs remain essential for expanding exports. Without these reforms, monetary easing would merely reignite inflation, while structural reforms alone would continue to be undermined by rising costs.

Pakistan's export stagnation is not simply the result of weak industrial performance. It also reflects years of monetary expansion that has consistently outpaced productive capacity. Treating broad money management as an integral part of export strategy would help create a stable, low-inflation environment in which Pakistani firms can compete on both price and quality.

Without stronger monetary discipline, repeated currency devaluations and incentive schemes such as the Drawback of Local Taxes and Levies (DLTL) are unlikely to produce sustained export growth. Instead, the country risks remaining trapped in a cycle of inflation, declining competitiveness and recurring external sector vulnerabilities.

The writer is a former vice president of KCCI, former board member of REAP and an international trade expert