Nevertheless, the entire developed world is opting for a tight monetary policy to contain inflation and not to impel its economic growth. Japan, for instance, has done away with its long zero rate interest rate policy as its economic revival gains momentum.
Central banks have no option save using the tight monetary policy to hold down inflation by raising interest rates. In the US, that has been done in recent times by raising the Federal rate by a quarter per cent at a time.
In Pakistan, the tight monetary policy last week expressed itself in the form of the State bank raising its discount rate by half a per cent- from nine to 9.5 per cent- for lending its money to banks for three days. This is a far higher rate than prevailing in many western countries where they seek a fine balance between economic growth and inflation.
Like many developing countries, Pakistan’s is a largely cash economy, more so, because its agriculture sector which contributes to 23 per cent of its GDP and where the rate of literacy is very low. The same holds good for the service sector which is much larger. In the rural areas, farmers do not have easy accessible to banks. Credit is given largely on the basis of collateral which many farmers cannot offer.
Hence the currency in circulation is very large, rupees Rs757 billion which pays for a great deal of the domestic trade transactions. Compared to that the total monetary assets are about Rs3200 billion.
In a country where the informal economy is very large, traders prefer cash transactions to using the bank. It is more reliable too in a country where the banks are open to the public for a few hours in the day.
Even now when credit cards are quite common in the big cities and are being promoted by its issuers vigorously, many popular institutions including petrol pumps prefer cash payments.
Business houses say it takes a long time to get money from the banks for the goods sold on the credit card. Some business houses charge an extra fee for accepting credit cards. The operation is far from smooth and can have several hiccups for the ordinary customers.
Much of the borrowing in the rural areas is from the local money lenders and the interest rate for regular customers for short-term loans are not very high. Apart from the money lent to the private sector by banks at a relatively low rate of interest, the sources of money supply are quite many and that money is afloat in the country pretty openly and makes demands on goods and services in plenty and pushes up prices.
And that money may be obtained through corruption or criminal means makes a significant contribution to inflation. To begin with such incomes, while very large, are tax-free and quite often spent rather quickly than accumulated in banks. In spite of the many directives of the State Bank to ascertain the sources of such large deposits and the credentials of their owners, they seldom do that or do that personally and there is the large tax evaded income which is spent openly as many persons are doing the same with impunity.
Corruption in the taxation services which makes such evasion very easy and increases the income and expenditure which aggravates the inflation further. Large development spending is immediately inflationary as the fruits the large scale development takes a long time in reaching the people. Machinery and other equipment imported are not inflationary.
Higher defence spending which this year has risen to Rs250 billion from Rs222 billion budgeted earlier last year is inflationary , particularly that paid as wages and allowances. F16s are not inflationary, but the wages paid to fly and maintain them are inflationary. Home remittances which touch the peak of over $4 billion promote inflation. They make demands on all kinds of goods and services and push up prices.
In addition, the overseas Pakistanis bring in a large variety of goods tax-free and sell them in the local market and make use of the money for buying other goods and services which push up the prices. In recent times a good deal of money coming from abroad as remittances was used for speculation in the real estate and on the stock exchanges.
The Chairman, Central Board of Revenue wanted the source of such inflows to be probed; he wanted to know how much of that money went out of the country evading taxes through the hawala and then came back as clean home remittance. But Prime Minister Shaukat Aziz stopped that lest it dries up this large source of income for the state. He wants more and more money to come home through this channel instead of that inflow drying up because of CBR intervention.
There is a demand from among exporters to devalue the rupee to make Pakistani exports less expensive and internationally more competitive. But the State Bank governor is opposed to that as it is a solution worse than the disease. At the inter-bank rate almost Rs61 to a dollar, while India’s rupee is 46.4 to a dollar, how much cheaper can we make the Pakistani rupee?
Devaluation will aggravate the inflation all round and make all imports far more costly particularly oil which has already touched $78 a barrel, while the price of palm oil too has been rising sharply.
The solution to the problem has to be sought by fighting inflation foursquare instead of trying extreme measures which are counter productive. Otherwise the development will also become too costly and the power crisis which has produced a good deal of violence will get far worse. The solution to inflation lies not in making the rupee cheaper, but the goods cheaper and easily available.
The drive to fight inflation has to begin with achieving the target of 6.5 per cent inflation for the current year which is not by any means low. Otherwise, the hardships of the people will increase in a critical general election year and an outburst of violence can become more frequent. The rise in inflation can also imperil the scaled down economic growth target of seven per cent for the year and there can be other negative economic consequences as well.
Clearly inflation cannot be fought in Pakistan through the monetary means alone, although that weapon must also be used. And the monetary restrain should have an increasingly large part in fighting inflation.
The State Bank governor does not want the government to do anything to add to the inflation. She does not want the government print currency notes to fill the Rs140 billion deficit in the budget. Instead she wants that the amount should be borrowed from the banks or from the public through the Pakistan Investment Bonds or the national savings schemes. Pumping Rs140 billion into the market can by highly inflationary and be contrary to the declared intention of the government to hold down inflation to 6.5 per cent in a period of rising prices all round.