WE have not been able to get the better of inflation. It is generalised and above comfort level. This is a huge challenge, unless we can learn to live with its stubbornness. The country’s growth prospects are being negatively impacted by its double-digit face, which is becoming the new ‘normal’. Inflationary expectations are getting entrenched, boosted by a depreciating rupee — the most important variable influencing the inflationary expectations of economic actors.

While there are several sources of inflation, its key drivers are internal in nature. Despite the contribution to inflation of the rising commodity prices internationally it is not clear how the globalised economy is acting as a limitation to the outcomes of the monetary policy.

The factors requiring a pause on the next steps and the need to remain shy of an overly reactive monetary policy stance for tackling inflation include uncertainty about the direction of inflation, the challenge posed by the low rate of growth and the lack of adequate data since the monetary policy impacts with a lag.

This writer has argued in these columns before that it is not possible to manage inflation through just one or two policy instruments. The reason is that the sources of demand in the economy are households, the corporate sector and the government, who in turn are receiving money from different sources — both internal and external (from domestic economic activities or from exports or remittances or, as in the case of government, loans or grants from external donors). The role of each source and what can be done about it is somewhat limited, especially because the acts of one actor/agent can nullify the actions of the others, at times as a result of unanticipated developments. For instance, the increase in the interest rate by the State Bank of Pakistan is supposed to change the behaviour of the borrower by reducing the demand for credit and thereby pruning the overall demand in the economy.

However, if that does not happen and the largest borrower — the government — continues to borrow and spend, it can completely negate the objective of the policy instrument of a higher interest rate. To illustrate this point further, it should be obvious that there are limitations of monetary policy instruments, like the interest rate, to fight seemingly unrelenting food inflation, the most pervasive aspect of our inflation, which touches the bulk, and especially the poorest households.

Again, policy instruments to contain domestic demand can be rendered redundant by inflows of remittances or donor assistance which simply serve to create additional demand for domestic goods and services.

It is factors like this that make it difficult to handle inflation and also because of the political economy complications of the effect of different instruments on the behaviour and earnings of these economic actors. Some of the latter have powerful lobbying capabilities or simply succeed in riding roughshod over any attempt to restrain them.

In this writer’s opinion food inflation has been the key driver of the high level of inflation domestically, and which has been broad-based, pervasive and relentless in nature, despite the anti-inflationary measures of the State Bank and government. It covers a majority of the items, although the greater impact has been on the relatively protein-rich items of pulses, milk, meat, poultry, etc. following the structural change in consumption patterns and dietary habits of a growing middle class.

An examination of this food inflation requires a deeper analysis of the problem. This must be done from the point of view of the supply shocks of natural calamities like floods, the policy to frequently increase the minimum support price of the principal food grain (wheat) and expansion of the network of the financial structure attracting rural savings into the system that pushes up the velocity of circulation of money ( reinforcing inflationary pressures). It must also be seen from the point of view of the rising cost curve and the poor supply-side response in the absence of a more open trade policy with India which would have improved the availability, and thereby prices, of food articles.

The principal factors pushing up the domestic production cost curve have been increases in administered prices of inputs like energy and oil and that of fertiliser pesticides, farm equipment, etc, structural weaknesses constraining increase in production, the fragmentation of land holdings, continuing poor yields per acre and almost stagnant government development expenditure on agriculture related physical and soft infrastructure. Controlling such inflation will require a comprehensive policy package comprising sensible fiscal and cash management, agricultural polices which incentivise increase in yields and cost efficiencies in production processes.

Another factor contributing to inflation is our tax structure. Apart from rampant tax evasion, we have amongst the lowest rates of income tax, complemented by several exemptions and no capital gains tax and wealth or inheritance tax. There is a resulting heavy dependence on rather high rates of indirect taxes in the shape of import, regulatory and excise duties, levies on petroleum and gas and sales taxes, which impact inflation acutely.

This discussion suggests that tackling supply side issues and those arising from the tax regime will in itself take time. In other words, we will probably have to learn to live with higher rates of inflation, at least in the medium term, because even if cost factors push up prices there has to be adequate demand for producers to be able to continuously pass on, wholly or partially, their increased costs to consumers.

The writer is the Vice Chancellor of Beaconhouse National University.