Rising inflation and declining value of the Pakistan rupee may bring disaster 1


By M. Osman Ghani

During 2007-08 Pakistan encountered two major shocks, namely, rising inflation and declining value of its currency. Every consumer now feels the burning heat of prices-spiral, and every labourer can calculate the changes in the real worth of the rupee now. Strong currency is an indicator of a strong economy.  When a person in the street thinks about the value of money, he is considering the value of his money and this can only be measured in terms of prices of the goods which he buys. Changes in the prices of some raw-material will affect the value of money used by the importer, the merchant, and the manufacturer for more than the value of the money spent by other groups. But as the prices level in an economy changes so far rate at which one good exchange for another is also changing. When an economy is prone to rising inflationary pressure, both due to endogenous and exogenous factors remedial measures are essential to maintain equilibrium among the major economic variables. Inflation leads to an arbitrary redistribution of real income the lower income, group and the salaried class suffering the most. The losers are those whose incomes are both low and fixed.

In economies such as Pakistan, which are dependent upon a high level of exports and imports, inflation often leads to balance of payments difficulties. If other countries are not inflating to the same extent, home-produced goods will become less competitive in foreign markets and foreign goods will become more competitive in the home market. Exports will be depressed and imports will rise. If this process continues it must lead to balance of payments deficit on the current account. The problem will be a particularly difficult one where inflation is of the demand-pull type, because in addition to the price effects the excess demand at home will tend to ‘draw in’ more imports. Every country endeavours to maintain value of its currency at par with other strong currencies so that its economic growth, price stability, investment and international trade remain on targeted path. A strong currency is an important contributor to political stability and prosperity of the people. In the recent past, a mighty military power crumbled and disintegrated mainly due to its shattered economy and unprecedented declining value of its currency.  

After witnessing stable and targeted growth of inflation during 2000-2004 (annual average at 3.8 per cent) there has been constant rise in prices and inflationary pressure became very much evident since 2006. During 2007-08 overall inflation was recorded at 12 per cent while food inflation witnessed unprecedented growth of 17.6 per cent. This more than normal rise in inflation has been fuelled by unprecedented increases in the prices of various food items both domestically and globally on the one hand and hoarding and profiteering on strategic food items on the other. In July 2007, food inflation was 8.5 per cent, while during July 2008 it was recorded at 33.8 per cent over the corresponding month of 2007. Inflationary pressure in Pakistan was also driven by a number of other factors including more than proportionate rise in the demands for goods and services, especially of imported consumers goods, like POL and a number of luxury items, like costly cell phone sets, luxury cars etc. simply creating ever increasing trade and balance of payment gaps. During 2007-08, imports of food group increased by 53.5 per cent while imports of petroleum group jumped by 55.1 per cent. Pakistan’s exports increased at a very slow rate of 13.2 per cent in 2007-08 as compared to 30.9 per cent in imports. During 2007-08 total trade deficit amounted to $20.7 billion while current account balance amounted to $14.1 billion. The increasing gaps of trade and current account balance is exerting tremendous pressures on the exchange rate of Pakistan which has increased from Rs56.7 per dollar in June 2004 to about Rs77 per dollar in mid August, 2008. (see table)

The foreign exchange value of a national currency is closely related to the country’s balance between exports and imports. It is also influenced by the capital transactions between that country and the rest of the world. It will be influenced by the speculators. Speculators buy and sell foreign currency with a view to making a capital gain. The great attraction of the floating rate is that it provides a kind of automatic mechanism for keeping the balance of payment in equilibrium. However, a major disadvantage of free or floating rate is that they add to a further element of uncertainty to international trading. In floating exchange rate buyers have two price levels to watch the foreign price of the commodity and the price of the foreign currency. The depreciation of the currency in the foreign exchange market makes imports dearer and this could lead to cost push inflation. A floating exchange rate can not insulate the home economy from external forces. Huge trade and current account balance exert mounting pressure to the home currency to shed its value against the strong currencies. Due to increasing and unfavourable balance of trade the exchange rate in terms of US dollars is constantly under pressure. Presently there are very few options to salvage this pressure as net inflows are also on the decline.

During the last 12-14 months major macro economic indicators have shown remarkable downward slide which is a matter of grave concern. For example,  rupee, after remaining stable for more than four years, lost significant value against the US dollar, depreciating by about 27 per cent from June 2007 to August 18, 2008. The movements in the rupee-dollar parity largely followed the same pattern as witnessed in the case of reserves. During the same period foreign exchange reserves have declined by $5.6 billion. The months of April and May, 2008 witnessed a steeper decline while the exchange rate remained under pressure, breaching the Rs64 per dollar mark in the month of April for the first time in six years. Rupee came under intense pressure in the month of May 2008 on account of speculative dollar buying in the market which prompted the SBP to take severe actions against the money changers to resist the sharp fall in the value of the rupee. This trend continued and rupee reached to an all-time low of Rs76.8 per dollar on August 18, 2008.

During 2007-08 tax to GDP has further declined to 9.4 per cent, gap of current account balance has further widened to 8.1 per cent and the GDP inflation has increased by 12 per cent. The budget deficit has increased to 7.5 per cent of GDP which is the highest rise since 1997-98. The rating agencies such as Standard and Poor’s and Moody’s have already downgraded Pakistan’s economy just because of the uncertainty that has gripped the country caused by poor economic governance. Also, due to rapidly eroding value of rupee the public debt has been swelling to unprecedented level.

Drastic dressing-down in the performance of the leading macro-economic indicators in the last one year is enough to open the eyes of the economic managers. Rising inflation and declining value of Pak rupee along with scarcity of essential food items are affecting the common man labourer and the retail business. Wheat floor and rice have already become rare commodities even in the federal capital area of Pakistan. The declining macro-economic trends of the last year must most not be allowed to continue in the current year to avert further economic crisis.

The major economic challenges can be faced, but it requires the will and the determination on part of the government and the citizens as well. The elected political leadership needs to put their heads together exclusively for improving the economic outlook of the country on war footing, otherwise the woes and miseries of the masses would keep on accelerating and they would be left with no choice but to remember the era of previous government as a better era. If this happens only anti people and anti democratic forces will be the beneficiaries.

SELECTED MACRO ECONOMIC INDICATORS

As per cent of GDP   2006-07        2007-08

Domestic debt          29.0    29.0

External debt  28.1    26.9

Tax collection 10.2    9.4

Budget deficit 4.3     7.5

Current account balance      -5.0    -8.1

Exchange rate (Rs)   60.0    76.8*

Forex reserves ($ billion)     15.1    9.5*

Inflation rate (%)     7.8     12.0

Food inflation (%)     10.3    17.6

·         18th August, 2008  Source: The News, 8/9/2008


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