Keeping inflation in check amidst tension on the eastern border has become a big challenge.

Depending on the success of Islamabad’s peace gestures, including the release of a captured Indian Air Force pilot, the return of normalcy will take time. So keeping the rupee stable and taming inflation can be challenging in coming months.

Already, the year-on-year rise in consumer inflation shot up to 8.2 per cent in February from 7.2pc in January, according to the Pakistan Bureau of Statistics.

If we keep this inflation number in mind and then recall that the rupee has also lost about 26pc value in the past one year, we realise inflationary pressure is building up in the economy. At the end of February 2018, the interbank value of the dollar was Rs110.76. At the end of last month, it was to Rs139.66.

Interest rate tightening has yet to help rein in galloping inflation because it will take more time to contract consumer demand besides the fact that currency in circulation keeps growing.

Currency in circulation has expanded to Rs390bn in the past seven and a half months as opposed to Rs177bn in the year-ago period.

Besides, massive government borrowing from the State Bank of Pakistan (SBP) — fresh currency printing in plainer terms — continues to fuel inflation. Between July 1, 2018 and Feb 15, the government borrowed Rs1.9 trillion rupees from the SBP, up from Rs575bn in the year-ago period.

Attempts to tame inflation and keep the local currency stable will become difficult if the security situation does not improve dramatically

With strong inflationary expectations created after the recent Pak-India hostile engagement, its impact on fiscal management and commodity markets and the overall increased level of uncertainty, you can figure out the future pace of price movements.

From March 1, the government has raised fuel prices by up to 4.85pc. That too is going to keep inflation up in the near future even if we see a downward revision in April for the simple reason that businesses are quicker in factoring in the impact of higher fuel prices but slower in adjusting for lower prices.

Expecting local fuel prices to come down in the next quarter of the fiscal year (April-June) would be naïve, keeping in mind the kind of fiscal disarray that the country was in even before the security situation became serious. The fiscal deficit in the first half of this fiscal year i.e. July-December 2018 stood at 2.7pc of GDP, the highest after 2.9pc seen in the first half of 2010-11, according to a recent Dawn report.

The fiscal deficit is sure to grow faster in the second half of the fiscal year due to less-than-targeted revenue generation, rising cost of domestic and foreign debt servicing and a possible increase in defence spending. The current account deficit might take longer than expected to decline if securing a $12bn IMF package gets delayed.

The impact of the twin deficits on the rupee and inflation might be quite challenging. Can the central bank go for further rate tightening — and that too at a time when large-scale manufacturing growth has turned negative? This really is an important point to ponder.

Another important moot point for policymakers is whether they can continue pursuing political bigwigs allegedly involved in cases of mega financial corruption, capital flight and money laundering as effectively as in the recent past during a challenging security situation. We should not forget that while the United States, China, Russia, Turkey, Saudi Arabia and the United Arab Emirates are playing their roles in defusing heightened tensions between Pakistan and India, New Delhi is yet to show a substantially positive response.

Besides, the fact that defusing this tension requires a serious crackdown against militant outfits makes the task of avoiding the economic fallout of any delay on this count quite difficult.

Attempts to tame inflation and keep the local currency stable are two things that will become very difficult in case the security situation does not improve dramatically.

At present, inflation dynamics of Pakistan have a couple of elements that are not so easy to handle. It’s not just consumer inflation that is accelerating. Inflation for the poor measured through the Sensitive Price Index (SPI) and core inflation are also high. Annualised core inflation was 5.2pc in February 2018, but it rose to 8.8pc last month. During the week that ended on Feb 28, the SPI showing the average change in the prices of 53 essential items shot up to 10.63pc. It was 5.52pc only 10 weeks ago.

Whereas keeping the SPI low requires higher agricultural productivity and smooth operations in the commodity markets, a high core inflation calls for the further tightening of interest rates, greater fiscal discipline and quicker fixing of external sector imbalances.

One silver lining is an apparent increase in the level of provincial harmony, which is so crucial for agricultural productivity. But will increased harmony obtained in the current security situation last permanently? Won’t further actions against top political leaders facing cases of corruption, capital flight and money laundering jeopardise it?

Another thing that remains to be seen amid the evolving geopolitical situation is the future course of dollar pumping into the national coffers by China, Saudi Arabia and United Arab Emirates in case an IMF bailout gets further delayed. The PTI government has got $7bn in total from these countries to keep foreign exchange reserves from falling too low.

Pakistan’s decision to boycott the recent Organisation of Islamic Cooperation meeting in protest against inviting India as a guest of honour has already created an unusual diplomatic situation. One can only hope that things will not take an ugly turn. Taming inflation and keeping the rupee stabile must be a priority as peace prevails.

Published in Dawn, The Business and Finance Weekly, March 4th, 2019