By Hasaan Khawar and Dr Zafar Iqbal
The State Bank of Pakistan has recently released the second quarterly report for FY 2007-08, unveiling the skyrocketing inflation figures. These figures came as no surprise to the masses, who are already crippled under soaring prices and severe shortage of essential food items.
Crude oil prices touching record high peaks are adding fuel to the fire. Under the circumstances one wonders who to blame for this massive price hike.
According to State Bank, high food inflation, owing to the rising international commodity prices as well as ‘factors related to domestic economy’, are the main culprits. This situation, besides exposing the vulnerability of our economy to international price shocks, has also bewildered people about what benefit, if any, they have extracted from the so-called phenomenal economic growth of the last five years.
Is our economy that vulnerable to external economic shocks? Are there any other factors responsible for this high inflation, besides the surge in international prices? And what can the government do to prevent such an untoward situation?
As experts are predicting one of the worst global food crises in history, the prices for food items are hitting a record high in the international commodity market. These prices coupled with an unprecedented hike in crude oil prices are further compounding the global inflationary pressures.
These factors however, are only responsible for part of the crisis that Pakistan is facing right now. After analysing the current economic situation, one cannot ignore such factors as government’s expansionary fiscal policy, the prevalent anti-competitive market practices, inefficient law and order situation resulting in supply disruptions and administrative decisions like the delay in passing on the oil price increase to the consumers.
The oil prices have been on the rise since last year. However, the caretaker government, apparently under political pressure, failed to pass on these increases to the public, fearing a political backlash in the upcoming elections. This delay, in turn, failed to check the consumer demand, which could have been substantially rationalised, if the price increase was passed on to the consumers. Such a demand rationalisation could possibly have resulted in significantly lower oil import bill and consequent reduction in current account deficit.
The anti-competitive market structure facilitated a few elements in cornering the wheat market and was hugely responsible for the increase in the flour price. Right before the elections, when people were waiting in long lines just to get a sack of flour and the government was desperately trying to import wheat at phenomenally high prices, the administration miserably failed to check the hoarders.
Not even n a single case was made public, where a hoarder of wheat was taken to task. The hoarding of essential food items like wheat therefore, pushed up the flour prices tremendously, resulting in a huge increase in food inflation.
The increase in food inflation is now responsible for 59 per cent increase in the CPI. Interestingly, in a country where agriculture is the backbone of the national economy and the main source of livelihood for 66 per cent of the population and accounting for 20.9 per cent of the GDP, it is surprising that why the local supply is so vulnerable that we cannot even meet our local demand.
Our fiscal deficit currently stands at around more than Rs359 billion, much more than what the government had expected. Most of this deficit has been funded by nothing else but the cheapest and easiest financing source available to the government, through expansion of M2 assets. This is in sharp contrast to the SBP’s recommendation to the government last year to retire debt of around Rs62 billion. This expansion in monetary assets apparently has played a key role in boosting aggregate demand and pushing the inflation further up.
The new government has also to deal with the dirty laundry of the last government. A case in point is the recent heavy oil subsidy, which was given in terms of issuing guarantees to oil companies, against which they borrowed the unpaid price differentials from the commercial banks, shifting the financial burden to a future date.
Most of the subsidy amount, if not all, is still to be paid and will have its adverse impact probably in the next financial year. Under this situation, the government has limited options to deal with the current crisis. On one hand, any decision to tighten the monetary policy runs the risk of generating a recessionary trend and on the other, the widening fiscal deficit is giving little room to the government to grant any relief to the consumers.
There is no single remedy for this chaotic situation and the government should adopt a multi-pronged strategy to tackle this issue. In the short term, the government should strengthen the administrative machinery, to check anti-competitive market practices, such as hoarding, as well as to ensure supply of essential food items.
In the long run, however, the focus should be on enhancing agricultural productivity, careful agricultural planning and maintaining strategic reserves of essential food items. The situation also highlights the need to thoroughly examine the prevalent market structures in the domestic food market, by organizations like Competition Commission of Pakistan, and design appropriate interventions to prevent these monopolistic trends in future.
On the energy front, the government must seriously explore alternative options including ethanol-based fuel. While this option has been tried on a limited scale, the minimal price differential has prevented any significant success so far. A focus on using higher ethanol percentage blends along with the introduction of flex-fuel engines, which can run on gasoline as well as ethanol blends, can significantly help in fighting the rising oil prices.
The burgeoning fiscal deficit demands a deep look at the tax and revenue structure, improving fiscal discipline, maintaining a sustained focus on austerity especially in relation to non-developmental expenditure, and ensuring efficient and effective working of bodies like Monetary and Fiscal Coordination Board, with the view to restrict deficit financing and inflationary implications.
Finally, the substantial growth in monetary assets, partly the result of deficit finance, raises serious questions about the independence of monetary policy, despite repeated claims by the previous government regarding the independence of State Bank. It is high time that monetary policy is freed from the clutches of political influence and SBP should be given clear targets on inflation control and financial stability.
In the end, it all boils down to the ambitious goal of improving economic governance which is easier said than done.
Source: Daily Dawn, 28/4/2008