ISLAMABAD, June 1: Tighter monetary policy in Pakistan is expected to stem increase in the inflation rate, said the World Bank.
In its latest report Prospects for the Global Economy Recent developments, South Asia regional outlook the bank termed the increase in the inflation as a serious challenge for the South Asian region.
It said that an inflationary spiral should not develop and that while large swings in food prices have contributed to the upswing in regional inflation, rapid increases in domestic demand (notably consumption) and low interest rates likely played a role.
However, the bank believed that in the current context, and especially with significant portions of high oil prices yet to be passed through consumer prices, a tightening of monetary and fiscal policy of the government of Pakistan was in order, if overheating and a hard landing were to be avoided.
Much of the increase in inflation stems from changes in food prices, with good harvests in Afghanistan, India and Pakistan leading to some easing or containment of pressures, while poor harvests in Bangladesh and Nepal created the opposite effect.
Although several countries have taken steps to pass on higher oil prices, explicit and implicit subsidies (through state oil companies) are imposing a heavy burden on the government purse.
They have increased government deficits by as much as 0.5 per cent of GDP in Pakistan and 0.7 per cent of GDP in India between 2002 and 2005, the report said.
In India, subsidies appear to have crowded out other development spending on health and education (Devarajan and Ghani 2006).
In India and Pakistan, the two largest economies in the region, growth was consumption-led, reflecting higher farm incomes and a relaxation of fiscal policy in Pakistan, plus an already lax fiscal and monetary policy stance in India.
The boost to private consumption represented almost three quarters of the increase in Indian GDP and more than all of the increase in Pakistan. In India, investment and exports continued to grow rapidly, but in Pakistan investment grew an anaemic 1.5 per cent while exports were up 7.8 per cent.
The acceleration of domestic demand in Pakistan was not met by domestic production and, as a result, imports rose by much more than exports.
Even in India, industrial production growth slowed from 8.5 per cent in 2004 to 7.8 per cent in 2005 and import growth outstripped exports by a significant margin suggesting that supply was unable to keep up with demand.
Notwithstanding double-digit growth in export volumes in 2005, the combination of higher oil prices and very strong consumption demand generated deterioration in the regional current account balance equal to two per cent of GDP.
The deterioration would have been worse, but the region has benefited from the removal of textile and clothing quotas, gaining market share, the report said.
While the clothing and textile exports of Bangladesh, India, Pakistan and Sri Lanka picked up, producers in Nepal and the Maldives lost market share.
In Bangladesh and Pakistan large remittance inflows in part stemming from the oil boom in the oil-exporting countries of the Arabian Gulf, where many South Asian migrant workers are based, also helped to offset the deterioration in the trade balance, while booming capital inflows have contributed significantly to meeting the financing requirement.
Reflecting very rapid increases in domestic demand, rising oil prices and a poor monsoon season in 2004, inflation in the region surged, rising from an average of 3.6 per cent in 2003 to 9.1 per cent in 2005.
These adverse trends are especially notable given that countries have yet to fully pass-through to the domestic market the entire rise in international fuel prices implying a backlog in inflationary pressures, the report added.
The monetary authorities in Bangladesh, India, Pakistan and Sri Lanka have reacted by raising policy rates, but real interest rates remain low (near zero in India).
The bank believes that economic activity in the region is projected to slow in 2006 through to 2008 as private consumption demand eases to a more sustainable pace in response to a tightening of monetary and fiscal policies.
