THE current inflation rate as measured by the consumer price index (CPI) – has come down from its higher level of 9.3 per cent in 2004-05 to eight per cent in 2005-06. The government plans to reduce it further to 6.5 per cent during the current fiscal year.
But the third quarterly report of the State Bank of Pakistan issued on July 15, the broadest inflation measure, the GDP deflator, has recorded an increase of 10.3 per cent in 2005-06.
During the previous two years, 2003-04 and 2004-05, also, the GDP deflator rose by nine and 8.8 per cent respectively. The inflationary pressure remains strong and it can push up the CPI in the months to come, unless effective measures are taken to counter the trend.
The SBP report points out that after declining steadily through most of July-April FY06, the wholesale price index (WPI) had jumped back to 9.1 per cent on year on year (YOY) basis in May 2006 from 8.1 per cent in the preceding month. This increase had reportedly been contributed both by food and non-food groups of the WPI.
The latest trend in respect of both the GDP deflator and the WPI points to an acceleration rather than deceleration of the inflationary pressure in the coming months. The rise in WPI (both food and non-food groups) has to result in higher retail prices, when goods purchased at higher wholesale prices enter the retail market.
Due to the spurt in the prices of sugar and pulses in recent months, the government decided to make the these items available to the consumers at subsidised prices at the utility stores. However, the number of utility stores being limited, these stores are unable to cater to even one per cent of the total population. The impact of the government measure is only marginal on the open market prices of these items.
According to some press reports in the last week of July, a survey had revealed that prices of a number of items namely tea leaves, vegetable ghee, meat, fruits and vegetables had also moved up in sympathy.
The prices of vegetable ghee/edible oil had gone up because the industrialised countries had reportedly diverted 40 per cent of their edible oil production for the preparation of blended fuel, due to unprecedented rise in the international oil prices. In Pakistan, also, blended fuel is going to be introduced from the next month, according to these reports.
It becomes clear that the counter-inflationary measures taken so far – including sale of certain items through the utility stores and appointing of price magistrates – have failed to help in arresting the rising trend in the prices of essential commodities.
As stated SBP report, the expansionary fiscal policy followed by the government was creating difficulty in controlling the inflationary pressure. The federal budget 2006-07 at Rs1315 billion was 19.7 per cent higher than the size of budget estimates for 2005-06. Similarly, the Public Sector Development Programme (PSDP) 2006-07 at Rs435 billion was 59.9 per cent higher. This has been made possible by raising the fiscal deficit from 3.3 to 4.2 per cent of the GDP.
In addition to the official expansionary policy, the liberal consumer financing and car leasing coupled with an unprecedented increase in income from home remittances had pushed domestic demand of local and foreign goods.
In fact, it was mainly this upsurge in aggregate demand that was the real culprit behind the current inflationary spiral and the record trade deficit of the outgoing financial year.
The SBP has decided to continue tightening of the monetary policy to bring the inflationary spiral under control. The private sector credit has decelerated to 19.5 per cent in July-June 10 FY 2006 from 29.7 per cent in the corresponding period of FY2005. The M2 growth has also simultaneously fallen to 13.3 per cent from 16.2 per cent.
In the latest move, the SBP has raised the bank rate further from nine to 9.5 per cent. It has also raised the cash reserve and statutory liquid ratios. These steps have been taken by the SBP to make the loans more expensive and reduce the capacity of the commercial banks to lend money.
At the same time, the SBP is reported to have asked the banks to ensure that they do not advance loans to those indulging in speculative hoarding of essential commodities. The SBP intends to devise a monitoring mechanism to make sure that the instructions issued by the central bank are followed by commercial banks, in letter and spirit.
The government can lend support in the counter-inflationary efforts by cutting its non-development expenditure and avoiding borrowing from the SBP, which is highly inflationary in nature.
If the current inflationary trend can be brought under control, it will also bring about marked improvements in other areas of the economy, namely the balance of payment (BOP) position and exchange rate stability. At the same time, a lower inflation rate would also be good for the long-term growth prospects of the economy.