KARACHI: The federal government’s increasing reliance on the petroleum levy is driving cost-push inflation across the economy, while higher interest rates imposed by the State Bank of Pakistan (SBP) are adding further pressure on businesses and households, according to a new research paper released by the Policy Research and Advisory Council (PRAC).
The report argues that Pakistan’s fiscal and monetary policies are working at cross purposes. While the government raises revenue through higher petroleum levies, contributing directly to inflation, the central bank responds by tightening monetary policy, increasing borrowing costs and slowing economic activity.
“The fiscal instrument creates inflation, while the monetary instrument attempts to suppress it at a significant economic cost to firms and households that have no control over either policy lever,” the report stated.
PRAC noted that inflation driven by administered fuel prices is largely unresponsive to higher interest rates. Traditional monetary policy works by reducing aggregate demand, but this mechanism is ineffective when inflation stems from government-imposed fuel levies rather than excess consumer spending.
“In such circumstances, policy-rate increases fail to address the root cause of inflation,” the report said. “Instead, they increase debt-servicing costs for businesses already struggling with elevated energy and production expenses, further squeezing profit margins and delaying private-sector investment.”
The study also highlighted what it described as an asymmetric transmission mechanism in the petroleum levy structure. When international oil prices decline, the government often increases the levy to generate additional revenue while keeping retail fuel prices within politically acceptable limits. As a result, consumers fail to benefit fully from lower global oil prices, and inflationary pressures persist through higher administered prices.
PRAC urged the SBP to incorporate this fuel-price transmission mechanism into its inflation assessments rather than treating fuel prices as purely external factors.
According to the report, Pakistan’s Consumer Price Index (CPI) fell to just 0.3 percent year-on-year in April 2025, the lowest level in decades, prompting the SBP to cut its policy rate by 150 basis points by December 2025, bringing it down from 12 percent to 10.5 percent.
However, inflation began rising sharply thereafter, reaching 5.8 percent in January 2026, 7 percent in February, and 7.3 percent in March, closely tracking increases in the petroleum levy, which climbed to Rs105.4 per litre on March 1.
The report identified April and May as the turning point, when inflation accelerated to 10.9 percent and 11.7 percent, respectively, coinciding with the petroleum levy reaching Rs117.4 per litre on May 9.
Transport costs emerged as the largest contributor to inflation, surging 36.8 percent year-on-year in May and adding 2.5 percentage points to headline CPI. Meanwhile, the housing, water, electricity, gas and fuels category recorded a 16.8 percent increase, contributing another 3.5 percentage points.
Together, these energy-related components accounted for six percentage points of the overall 11.7 percent inflation rate, representing more than half of headline inflation. The miscellaneous category, which rose 15 percent, reflected the broader pass-through effects of higher fuel costs on consumer services.
PRAC noted that the SBP’s April policy rate increase came precisely as petroleum levy-driven inflationary pressures were intensifying.
The report also examined developments in diesel pricing. In February, diesel carried a levy of Rs76.2 per litre. In March, the levy was reduced to Rs55.2 as global oil prices surged and the government sought to keep retail prices stable at Rs335.9 per litre.
As international crude prices continued rising, ex-refinery diesel prices reached a record Rs496.97 per litre in early April. To cushion consumers, the government temporarily removed the diesel levy altogether. Despite this, diesel prices climbed to Rs520.4 per litre on April 4 and remained at that level for more than a week.
With global oil prices subsequently easing, the government gradually reinstated the levy. Between May 1 and May 30, the diesel levy was increased five times, rising from Rs28.7 per litre to Rs68.9 per litre.
The report concluded that the combination of rising petroleum levies and tighter monetary policy is placing increasing strain on economic growth, while offering limited effectiveness in controlling inflation driven by energy costs.
Story by Shahid Iqbal
