Inflation worries — search for a cure

Published April 5, 2021
In this file photo, people buy vegetables from Karachi's Empress Market. — Photo by Shahab Nafees/File
In this file photo, people buy vegetables from Karachi's Empress Market. — Photo by Shahab Nafees/File

Given the rate of inflation that has taken place, Prime Minister Imran Khan has removed unelected technocrat Dr Abdul Hafeez Shaikh and given the additional charge of the finance ministry to Federal Minister for Industries and Production Mohammad Hammad Azhar. He has been tasked “to devise policies according to ground realities of Pakistan and (ensure) the poor get relief.”

The portfolio for finance has been clubbed together with industries and production apparently for better policy coordination and decision-making in changing policy priorities. The ground realities demand the current disconnect between fiscal/ monetary policies and the real economy — that produces goods and non-financial services — be significantly reduced to improve the fundamentals of the economy. For example, the World Bank experts say that Pakistan exports will dip further this fiscal year.

The ground realities demand the current disconnect between fiscal/ monetary policies and the real economy — that produces goods and non-financial services — be significantly reduced to improve the fundamentals of the economy

On his first working day as finance minister, Mr Azhar had a meeting with State Bank of Pakistan (SBP) Governor Dr Reza Baqir. It may be recalled that under the fiercely criticised International Monetary Fund (IMF) induced bill on SBP autonomy submitted to the National Assembly, refinance facility would continue as long as considered necessary by an independent regulator keeping in view the overriding objective of maintaining price stability. The government borrowings from the central bank has already been reduced to zero as an IMF conditionality.

The SBP’s support for the government’s economic policies, to quote an analyst, has been relegated to ‘tertiary’(not even secondary) objective. The federal cabinet is reported to have approved the bill without dwelling on its details.

Banks’ risk-free investments in government papers have shot up by 33 per cent year-on-year in February while advances that stimulate economic activities recorded a paltry growth of 3.8pc despite the surge in subsidised pandemic-related credit. Pakistan’s economic growth for the current fiscal year is estimated by the World Bank at 1.3pc while the public debt will hit a record of 94.4pc of the GDP — up from 72.5pc in July 2018 when PTI came into power. And the fiscal deficit will remain at 8.3pc of GDP.

In the past, the industrial revolution was fuelled by finance capital and interrupted energy supplies — areas that are problematic for Pakistan. Fiscal expansion without a corresponding increase in production and supply fuels inflation. The World Bank estimates that inflation will remain at 9pc at the end of this fiscal year. To go back to the basics, prices are the end product of all economic activities.

Trade and industry representatives have severely criticised the monetary policy for cost-push inflation particularly when the interest rate and rupee depreciation hit their recent peaks. The Planning Commission, responsible for socio-economic development, said recently that the current 7pc policy rate is high compared with those in the region and should be reduced.

Dr Sheikh’s abrupt removal just when the next year’s budget is around the corner has also undermined the powerful position of the finance ministry, only next to that of prime minister since the past few decades, tilting fiscal policymaking into the domain of elected representatives. It also demonstrates that it is beyond the realm of technocracy, including IMF prescriptions, to effectively resolve deep-seat multiple crises. The perception that Fund reforms bring about cosmetic changes is gaining ground among national financial analysts, economists, policymakers and parliamentarians

It may be recalled that Asad Umar was removed as finance minister after eight months of his tenure, the former SBP governor was asked to resign and the then finance secretary had to quit his government job trying to negotiate a sensible deal with the IMF by seeking to soften the impact of upfront original bailout conditionality.

Further hit by Covid-19 fallout, the poor, jobless and the vulnerable whose real incomes have been reduced, are the worst sufferers and there is no real solution in sight. The World Bank appraisal report estimates two million people have fallen below the international poverty line of $1.9 per day and 40pc of the households are suffering moderate to severe food security.

The gulf between technocrats and elected representatives widened because of some worsening economic trends and finally forced the government to issue two ordinances, one to raise taxes and the other to surrender its own authority for setting energy tariffs. Measures that will fuel inflation.

As a prior condition to the latest released IMF tranche of $500m, the bill was designed to amend the central bank’s original dual mandate granted by the State Bank Act 1956 for promoting economic growth and ensuring price stability. The proposed primary objective of the central bank was to ensure price stability, not growth.

A relevant issue in controlling inflation that has surfaced in the fierce national debate on SBP autonomy more lucidly is: what is the real cause for inflation? Over at least the past decade inflation in Pakistan has been a function of the supply-side factors, terms of trade shocks, currency devaluation, administrated prices (such as electricity tariffs), market imperfections rather than excess demand, says economist Sakib Sherani. He argues that with an average growth rate of 3.6pc over the last ten years, the county is operating at approximately half of its potential rate of output growth. Inflation needs to be contained by applying the right policy instruments. Inflation targeting is not one of them.

We are now in a phase of low economic growth and high inflation. During the last PML-rule, we witnessed moderately high growth with low inflation. This exposes the myth that growth always heats the economy. The growth rate forecast for the current fiscal year ranges between 1.3-3pc, subject to the risks from the third pandemic wave.

Turkey recently dismissed its market-friendly central bank governor a day after he raised the interest rate to 19pc and appointed in his place another central banker who shares the country’s president’s unorthodox view that high-interest rates fuel inflation.

The frequent hikes in energy prices are also a cause for inflation. Empowering the regulator through an ordinance to enforce its decision on energy price hike without government intervention would in essence represent the continuation of a failed strategy of lending institutions imposed on Pakistan to counter the disastrous consequences of the World Bank-supported 1991 policies, says Sherani. And as an energy expert says, without reforms and improved efficiency of utility companies the tariff increases would be counterproductive.

Policymakers should do a proper diagnosis and on that basis find appropriate long–term solutions to tame inflation.

Published in Dawn, The Business and Finance Weekly, April 5th, 2021

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