Karachi: The State Bank says that increasing climate intensity is also negatively affecting its monetary policy and impacting price stability. The State Bank has included a special chapter on this issue in its half-yearly review for the current fiscal year, examining the impact of climate change on price stability and monetary policy.
In its review, the State Bank says that climate shocks affect price stability in different ways, and the effects of climate change can be both short- and medium-term. Environmental changes also increase the risk of rising inflationary pressures.
The State Bank stated that floods, extremely high or low temperatures, and droughts disrupt the supply chain system for goods and commodities. Climate intensity can negatively affect agricultural production, resulting in fluctuations in food prices. Similarly, damage to transport infrastructure, trade disruptions, and policy spillovers can also have varying impacts on prices. Meanwhile, certain environmental protection policies, such as carbon pricing, can create structural changes in the economy’s price system and contribute to higher inflation.
Research studies show that rising temperatures negatively impact headline inflation in both low- and high-income countries. Among the various components of inflation, food inflation is the most affected by climate intensity, and these challenges impact poor, developing, and developed countries alike.
The report states that short-term climate changes, particularly rising temperatures, negatively affect crop yields, leading to higher prices. A study covering the period from 1979 to 2020 in Pakistan identified a negative relationship between temperature, rainfall, and wheat production, which contributed to an increase in food inflation.
Similarly, floods also increase inflationary pressures in the short term. To support this point, the State Bank cited the example of the 2010 floods. During the floods, disruptions in the supply chain caused food prices to rise sharply. Government expenditures also increased to deal with the flood situation, forcing the government to borrow heavily. This significantly weakened the effectiveness of the State Bank’s monetary policy, making it difficult for the central bank to control money supply and inflation.
On the other hand, although the effects of the 2022 floods were short-term, inflation surged sharply in the months following the disaster. According to State Bank staff estimates, the floods made an immediate and positive contribution to inflation in the National Consumer Price Index (NCPI). The State Bank’s analysis suggests that temperature shocks could increase inflation over the long term.
Climate shocks also create challenges for central banks in achieving monetary policy objectives. For example, fluctuations in food prices affect inflation expectations and create risks for central banks’ inflation forecasts. This situation was observed in fiscal year 2023, when the continuing effects of the 2022 floods in Pakistan, exchange rate movements, and other supply shocks increased inflation volatility and forced the State Bank to revise its inflation projections.
The State Bank says that rising climate risks and asset losses also weaken businesses’ repayment capacity and banks’ balance sheets. As a result, lending becomes limited and the effectiveness of monetary policy is reduced. These risks require greater vigilance from central banks. However, limited availability of climate-related data, lack of expertise required to forecast climate events, and difficulties in identifying and measuring the transmission of climate impacts are major obstacles in designing an appropriate monetary policy response, ultimately affecting price stability.
