Inflation, in nine months of this fiscal year, rose at an average rate of eight per cent against the full year target of 6.5 per cent. A senior official of the ministry of finance said, inflation might decline in the remaining three months. “But it would settle around 7.5 per cent at the end of the year.”

The State Bank of Pakistan (SBP) said in its second quarterly report that overall inflation might range between 6.7--7.5 per cent. The SBP Governor, Dr Shamshad Akhtar told Dawn that average inflation might close somewhere between 7-8 per cent by year-end. (See box)

The Asian Development Bank has projected seven per cent inflation. And this projection takes into account the impact on the price-line of reduction in domestic petroleum prices in January and continued tightening of the monetary policy.

Pakistan is experiencing a high inflation not only as a by-product of a faster GDP growth but also due to rise in food prices and as a result of an expansionary fiscal policy.

Food prices’ inflation rose 10.34 per cent in July-March FY07, against 7.37 per cent a year ago. Average inflation measured by Wholesale Price Index was 8.52 per cent during this period, up from 7.48 per cent. Since half of the increase in WPI inflation originated from higher prices of raw materials it continues to trickle down on consumer prices as well. The government would set major macroeconomic targets including that of inflation for FY08 later this month.

Official of the ministry of finance say that inflation target might be set at six per cent. But the SBP governor says it might be 6.5 per cent. However, the people would like to know, however, how the government and the SBP would contain inflation in the next fiscal year after they have failed in this task during this year.

Concerns on high inflation are growing also because low-income groups often suffer higher than average inflation. (Sometimes the trend changes —but only briefly like it did in March 2007 when inflation for the highest income group was higher than the overall CPI inflation).

Many a time, inflation measured by Sensitive Price Index (SPI) remains higher than the benchmark CPI inflation. This also indicates that the poor suffer from higher incidence of inflation.

It is true that the government can keep the prices of essential items stable through supply-side management and administrative measures. But the tendency of the central bank to watch core inflation more closely affords the government the laxity with which it deals with the issues that directly affect prices of the items of daily use including food and fuel.

The SBP tries to keep a balance between inflation and growth rather than just ensuring price stability and it tends to take credit in keeping core inflation in check.

In practice, people are concerned with the overall inflation. And they are even more concerned about which sub-indices of CPI push up inflation. The contribution of food group was 57.4 per cent in overall CPI inflation in March 2007, up from 32.6 per cent in March 2006. This again indicates that the poor are hit harder by inflation.

In the next fiscal year, keeping food prices stable would be a key challenge for the government because there is no hope for a dramatic rise in agricultural output. And attempts to supplement local food supplies with imports would further expand the trade deficit that is already at historic highs and creating problems in balance of payments management.

For the central bank, the most important challenge in the next fiscal year would be to curb demand pressures in the backdrop of a populist budget and expansionary fiscal policy. Prime Minister Shaukat Aziz has already said the government would not only improve the pay structure of its employees but would also set a higher benchmark for minimum wages.

Moreover, further spending on resettlement and rehabilitation of the October 2005 earthquake victims and initiation of big infrastructure projects would make fiscal policy all the more expansionary. And as such, the role of the monetary policy in fighting inflation would be central.

SBP Governor Dr Shamshad Akhtar has, however, made it clear that monetary policy alone would not be able to contain the rise in inflationary pressures. Speaking at the FPCCI on April 30 she said: “The government will need to continue to alleviate supply-side constraints because of problems of market structure and distribution system.”

She went on to say that “success in containing inflation further depends on continued effective monetary management which requires minimising the government’s recourse to central bank borrowing, mitigating the monetary pressures arising from the surge in capital flows ensuring that these are sterilised.”

Dr Shamshad also revealed on this occasion that SBP would be launching preparatory work on inflation targeting to curb inflation more effectively. But before that there will be a need for introducing supportive legal and regulatory framework which allow for targeting inflation and for greater operational independence to the central bank.

She almost stunned the audience when she revealed that between July 1, 2006-April 14, 2007 the government borrowing from the SBP stood at Rs180 billion compared with only Rs37 billion in a year-ago period.

Officials of the ministry of finance say that the government has started reducing its borrowing from the central bank and it is now borrowing more from banks and non-bank sources. They say that this trend would continue in the next fiscal year. (On April 28, 2007, government borrowing for budgetary support from the SBP sank to Rs3 billion but its borrowing from the banking system shot up to Rs171 billion surpassing the full fiscal year target of Rs120 billion).

Officials say that National Saving Schemes (NSS) have once again become an effective tool to borrow from non-bank sources, which is least inflationary. In nine months of this fiscal year, NSS attracted net inflow of Rs44.6 billion. In the last fiscal year net inflow in NSS was Rs6 billion and a year before there was a rather net outflow of Rs50 billion.

As for checking volatile food prices, the government says it would further strengthen the concept of consumer courts and price magistrates besides offering incentives to farmers to produce more food crops. “I cannot give you the details, but you will see in the budget these and other measures that would be taken to keep inflation in check through supply-side management,” said a ministry of finance official.

He admitted that by keeping the interest rates high, the SBP has left no room for hoarding and unnecessary inventory building which was a cause for pushing inflation up in FY05 and before. “Now it’s our turn to curb hoarding through administrative measures and we are committed to doing that,” he said.

He made a quick reference to the plans for making Monopoly Control Authority a more powerful body “that would not allow distortions in the market that do many harms and eventually lead to inflation.”

Keeping a balance between a desired level of growth within a targeted level of inflation would be a challenge in the next fiscal year for another reason.

Since Pakistan has started experiencing huge trade deficit, imported inflation would keep creeping in. And as the government would seek larger foreign exchange inflows to keep its balance of payments in shape these inflows if not sterilized efficiently, would push up inflation.

In fact, one of the reasons for inflation remaining high during this fiscal year is a build- up in net foreign assets on the back of unexpectedly high foreign exchange inflows through workers’ remittances and foreign investment. Between July 1, 2006 and April 28, 2007 NFA grew at the rate of 12 per cent showing a 100 per cent increase over its growth rate of six per cent a year ago.

Also, currency in circulation grew at the rate of 13.4 per cent, up from 12 per cent in a year-ago period. This faster growth in CiC needs to be checked effectively without which it would be very difficult for the central bank to fight inflation effectively.