Inflationomics

Although much of the logic that supported the traditional economic axioms and theories (assuming rational human behaviour) appears to have become inapplicable courtesy the fallout from the current recession, economists are still reluctant to accept this change.
I recall an instance in 2009, when the Fed Governor Ben Bernanke was questioned by a select committee of the US Senate on monetary issues that started to get out of control. The question posed was "why is the Fed's discount rate aligned with the core inflation index and not consumer price index (CPI)?"
In response, he said that interest rates can't be aligned with price indices that include goods and services whose prices fluctuate too often because that would destabilise the financial system. Hence, core index, that excludes volatile food and fuel prices, is chosen as the yardstick.
The logic makes sense - system stability - but only if, as percentage of the total expenditure of the majority of in a country, food and fuel constitute a minor share, say, 20 to 30 percent. Given the large-scale unemployment there, this logic no longer applies even to the US.
Given Pakistan's economic realities, Bernanke's logic doesn't apply here at all. In an inflation-inflicted Pakistan, food and fuel costs now constitute between 45 to 75 percent of the total expenditure of almost 80 percent of the population. CPI is the major factor that now impacts life, and the propensity to save.
No wonder Pakistan Bureau of Statistics (PSB) has been changing the base year for working out changes in CPI to reflect as a low a rise therein as possible. Reason: containing the rise in 'real' CPI (largely, the outcome of hoarding) is beyond the capacity of the government.
No government anywhere has the resources to catch every wholesaler or retailer involved in practices fuelling inflation. In Pakistan, retailers alone add up to over 3 million. The huge majority of this sector will behave only if tough self-regulatory codes (non-existent yet) promptly blackball the corrupt.
No chamber of commerce and industry explains why it can't take regulatory steps to check that part of inflation which results from hoarding and avoidable supply uncertainties that trigger unwarranted price increases at wholesale and retail levels, and render real interest rates negative.
After State Bank of Pakistan (SBP) cut its discount rate on October 5, businesses demanded that mark-up rates must come down to 8%. Given the failure of the chambers of trade and industry to check inflation (reflecting zero concern for self-regulation), can they demand mark-up rates of their choice?
Their demand implies that SBP discount rate must drop to around 6% and, impliedly, profit rate on savings come down to around 2%. This is possible, but will the businessmen agree to at least bring CPI down to 2% so that the real profit rate on savings is at least zero, not negative?
That the chambers of commerce and industry can't see the criticality of keeping inflation low to induce a higher level of saving, is unfortunate. As long as they won't accept this reality, real interest rates will stay negative and savings never enough to meet the needs of the economy.
As of now, the only way mark-up rates could be lowered would be for the state to do what is already escalating the fiscal deficit-subsidise this cost and forego the achievement of far more important economic objectives, particularly development of the country's crumbling infrastructure.
Trade bodies never lose any opportunity (though rightly) of faulting the government for the ever-expanding gaps and flaws in the country's physical infrastructure, but can't see that unless domestic savings rise, resources for development won't be available.
That the power sector crisis is virtually eating away the roots of the economy is undeniable. But, wasn't this crisis building up since the early 1990s? The chambers of commerce and industry did not push the government hard enough to check this developing black hole.
Instead of asking for higher domestic oil and gas output, building more dams to generate cheap hydro-electricity, technology revamp at power houses, and containing line and distribution losses, they quietly watched (and also participated in) the deadly switchover to 'rental power'.
Throughout this critical period, the chambers of commerce and industry sought tax cuts and rebates as the route to containing their costs. Was it going to work? The solution lay in increasing their own efficiency and that of the power sector, and reduction in its dependence on fossil fuels.
The all-round low focus on improving efficiency - in the industry itself and the power generation sector - and a pronounced tendency for asking for low mark-up rates, tax cuts, and rebates reflects a mercenary attitude that doesn't befit businesses; they need to be futuristic in their approach.
Negative real rates of return on savings are a continuing tragedy that never allowed savings' growth rate to reach the minimum of 20% needed to drastically cut reliance on external resources for plugging the gaps in the physical infrastructure. The result: Pakistan's external debt is now at a suicidal level.
Pakistan's current circumstances reflect an inability to appreciate the need for offering real positive returns to the savers, and fallout of the investment unfriendly environment that now prevails. External resources can now come only in the form of debt, with tough conditionalities.
The variety of responses to the latest reduction in SBP's discount rate forced the SBP Chief Economist to say that interest could also go up if the expectation - stable inflation - that encouraged the latest cut in discount rate does not materialise. It is a warning that must be heeded.
If inflation, (especially CPI) gradually doesn't go down real interest rates will remain negative and savings will keep sliding, which is no longer affordable because until the other negatives - security risks and power shortages - are contained, foreign resource inflows are unlikely.
It is time the chambers of commerce and industry paid serious attention to devising tough self-regulatory codes for checking artificial price rises to ensure that real inflation stays low, and allows real interest rates to become positive to serve as an incentive for higher saving.
The other aspect that they must focus on are the industry's flawed labour, and internal safety and security practices, as highlighted by the recent tragedy in Baldia Town, Karachi. It seems that the lessons learnt haven't prodded action because similar tragedies continue.
These failures reflect a dangerous level of self-deception ie things are okay as they stand; improving them is someone else's responsibility because we are here for profit. This mindset must change to accept what has been denied thus far - looking at the big picture.