Economic Growth Under Pressure: The Role of Inflation, Interest Rate, and Tax in Pakistan

Abstract

The study analyzes the effect of macroeconomic factors like inflation, interest rates and taxation on the economic growth of Pakistan during 1990-2024. The study uses the World Bank, State Bank of Pakistan and Pakistan Economic Survey data and adopts Autoregressive Distributed Lag (ARDL) model, Newey-West robust regression, Granger causality test and diagnostic tests to explore short run, long run relationships between the variables. The results show that the tax rate has a positive strong effect on the economic growth in the short run (p<0.05), and exchange rate fluctuation has an adverse strong effect on the economic growth in the short run (p<0.05). The results indicate a small positive impact of FDI outflow, while the remittances have a negative effect on GDP, contrary to the expectation, indicating some inefficiency in using remittance inflows. Since the ARDL bound test showed the presence of a long run cointegrating relationship among these variables, but individual long run coefficients were not statistically significant at conventional levels, the examined variables are not long run cointegrated. The results from the diagnostic tests indicate that the model appears stable and that there are no serial correlation, heteroskedasticity or specification errors. The results of the Granger causality tests suggest that the exchange rates Granger-cause GDP, while no causal relationship is detected for remittances, FDI inflows, FDI outflows, inflation, and taxes. The findings highlight the significance of good tax policy as a catalyst to economic growth in Pakistan and the need for sound policy on exchange rates to cushion the impact of shocks. The study calls for further improving the efficiency of tax collection, expanding tax base and redirecting remittance funds into productive investments to ensure sustainable economic development. Fiscal and monetary policy coordination is crucial to minimize economic uncertainty and provide a conducive atmosphere for investment in Pakistan.