WASHINGTON, June 12: Pakistan’s monetary policies played a ‘decisive’ role in driving up inflation in the country during 2004 and 2005, says an IMF country report released on Monday.

The report notes that inflation in Pakistan ‘rose rapidly’ in 2004 and ‘remained high’ through 2005. Generally, two factors – an increase in the wheat support price and monetary growth – are blamed for this rapid increase, the report adds.

After examining both the factors, the IMF study finds “strong evidence that the influence of monetary policy is decisive.”

The report notes that after the financial crisis of 1998–99, Pakistan’s inflation dropped to less than 5pc a year and remained at that level through 2003. “Tight monetary policy, combined with fiscal consolidation, contributed to this low-inflation environment,” the report adds.

Starting in 2002, however, monetary growth picked up, and inflation, with a one-year lag, increased sharply in late 2003 and 2004. This acceleration also coincided with two increases in the wheat support price.

To take a closer look at what was driving Pakistan’s inflation; the study examines the role played by monetary growth, real GDP growth, the interest rate, exchange rate movements, and increases in the wheat support price.

“The results suggest that monetary factors are the main drivers of inflation in Pakistan,” IMF concludes.

The study points out that monetary factors particularly private sector credit, affect inflation with a lag of about one year. In addition, increases in the wheat support price influence inflation in the short- run. Thus, over the medium-term, the wheat support price can affect inflation only if accommodated by monetary policy.

To test these findings further, the study tracks the effects of increases in the wheat support price in 1999, 2003, and 2004. When the price was increased in 1999, monetary growth was subdued and inflation remained low. Pakistan experienced a slight increase in headline inflation in mid-2000, stemming from non-food inflation, but this suggests that the wheat support price played only a small role, if any, in explaining headline inflation.

In contrast, when the wheat support price increased in 2003 and 2004, monetary growth was high and increasing, which triggered non-food inflation. Food inflation rose even more, which could reflect the additional impact of increases in the wheat support price. And, given the accommodating monetary conditions, there may indeed have been second-round effects from food to non-food inflation.

The study urges the State Bank of Pakistan to strive for price stability as its ‘overarching objective.’ “High and persistent inflation is a regressive tax that hurts the poor. There is also evidence that inflation beyond a certain threshold hampers growth and financial sector development.

For Pakistan, this threshold is estimated to be in the 3–6pc range, says the IMF report. Declaring the government’s medium-term inflation target of 5pc as appropriate, the study suggests that “in the future, monetary policy will need to focus foremost on keeping inflation close to this target.”