WHILE the State Bank of Pakistan has been tightening its monetary instance, inflation continues to remain a threat. Despite a decline in the consumer price index (CPI) from 9.3 in 2004-05 to eight per cent in 2005-06, the GDP deflator — the broadest inflation measure — witnessed an increase of 10.3 per cent in 2005-06.

The wholesale price index (WPI) had, also, jumped to 9.1 on year on year (YOY) basis in May 2006 from 8.1 per cent in April 2006.

Weekly wholesale prices of selected items, reported in the press showed that prices of wheat, pulses and rice had continued to show an upward trend in July and August, while media reports had revealed that prices of a number of other items such as vegetable ghee, edible oils, meat, fruits and vegetables etc. had also gone up during the last few weeks.

The price increases are being attributed to the advent of the holy month of Ramadan, which is only a few weeks away. Besides, the monsoon rains and floods had also contributed to the upward trend in prices by causing interruption in supplies of items of daily use and pushing up the transportation cost in certain cases.

In addition, this is off season for sugar, since the new crushing season normally starts in October. This may be the reason for the higher prices of the item in the open market, despite liberal imports and sales at subsidised prices through the utility stores. This is the off season for rice also, which is harvested in December. As a result, prices of certain varieties of rice have registered an increase in the wholesale market. Another reason for the increase in the prices of rice is that the export of rice is expected to go up to a record $1.5 billion during the current year.

The situation can, no doubt, be remedied by boosting the production of wheat, rice, pulses, potatoes, onion and all other agricultural products and streamlining the distribution of items of daily use.

The distribution system can be improved by substantially increasing the number of utility stores. Under the Rozgar scheme, reportedly being launched from the next month, more utility stores can be opened by those granted loans loan for the purpose.

Although a multi-pronged strategy may be required to bring the inflationary pressure fully under control, the tightening of the monetary policy by the SBP is necessary to deal with the demand-pull inflation due rise in family incomes from home remittances and liberal credit policy of previous years.

After the announcement of its monetary policy for July-December, 2006, the Pakistani rupee has remained stable vis-à-vis the dollar, both in the inter-bank and open market. A press report on August 16 said the food inflation had shown a decline of 0.34 percent in July 2006 as compared to June 2006. However, it is feared that prices may generally remain under pressure until the end of the current monsoon season and the holy month of Ramadan.

The trade deficit of $1.23 billion in July 2006 shows that the demand for imported goods continued to remain at a high level. It appears that the latest SBP measures would take some time – three to six months – to make their impact felt on the economy.

Tightening of the monetary policy – also called inflation targeting – has been followed around the world since long. To quote an instance, the US broad inflation rate exceeded 10 per cent in 1980-81. Paul A Volker, who was the Chairman of the US Federal Reserve at that time, raised the federal rate to as much as 19 per cent with the full backing of the then President Reagan. The policy worked and the inflation rate came down to three per cent by 1983.

Later, in the same way, Alan Greenspan – former Chairman of the US Federal Reserve – raised the federal rate to 9.75 per cent in February 1989 to bring down inflation from its higher level. The initiative worked, but the US economy slipped into a mild recession in July 1990, that lasted until March 1991. The action was taken by the US Federal Reserve, although the country dos not target formal inflation rates.

The reduction in the rate of inflation is necessary not only to protect the macro-economic stability but also to safeguard the long-term growth prospects of the economy.

To make the monetary policy work, the government should take necessary steps ensuring the success of the counter-inflationary measures introduced in the federal budget, 2006-07 (sale of items of daily use through the utility stores and appointment of price magistrates).

At the same time, the government should make all possible efforts to bring down the trade deficit from last year’s over $12 billion to $9.4 billion as envisaged in the current year’s trade policy, announced in July.

It would be desirable to be content with modest growth, while protecting the macro-economic stability and safeguarding the long-term growth prospects of the economy than to boost the short-term GDP growth through higher public and private spending, allowing inflation and fiscal and current account deficits to go up to a point, from where they could cause irreparable damage to the economy.