Currency in circulation and inflation

It seems that Finance Minister Hafeez Sheikh tries to utilise every opportunity to educate legislators of the country about the fundamental principles governing various areas of the economy including the financial sector and their inter-linkages.
In a written reply to a question on 29th March, 2011 by Senator S. M. Zafar, whether inflation had increased due to printing of new currency notes, Hafeez informed the Senate that during FY11 (ie between end-June, 2010 and February 15, 2011), currency in circulation had increased by Rs 263 billion or 19 percent whereas currency notes worth Rs 153.8 billion were printed during FY10.
Due to higher level of currency in circulation, the currency-to-deposit ratio rose to 33 percent in February, 2011 as compared to 29 percent at the end of June, 2010. The prime reason for this was heavy government borrowings from the State Bank of Pakistan for budgetary support, which essentially means new money in circulation and this phenomenon/process adds to inflation.
However, an understanding had now been reached with the SBP to restrict such borrowings at the end-September, 2010 level of Rs 1,290 billion. This would help in restraining the printing of new currency notes and reduce currency in circulation. Hopefully, the reply of Hafeez Sheikh to a very pertinent question raised by S. M. Zafar would not only satisfy him but also add to the knowledge of other legislators besides raising the awareness level of those who can afford to read the newspapers in Pakistan.
In a way, it would also help dispel the general perception in the country that almost all the tax mobilisation measures are inflationary and, as such, needed to be opposed tooth and nail. The reply of Finance Minister implies and rightly so that if higher revenues are not mobilised through additional tax measures and fiscal deficit is not contained within reasonable limits, government would be constrained to borrow more from the State Bank which, in turn, would meet the government's requirements through printing of more notes and adding to the currency in circulation.
Since such a course of action would increase effective demand in the economy, it would also be inflationary and be more harmful to the poor and lower-middle classes of society than ordinary tax measures to raise budgetary resources in order to reduce the need to print currency. For instance, if the trade-off is between raising the electricity tariff and providing subsidy through the budget, it would be more equitable and morally justified to raise electricity tariff since the households who use electricity are relatively well-off and should be required to pay the full cost of utility provided to them.
There is no reason to tax the poor in the form of inflation who are unable to afford the luxury of consuming electricity. Although, the reply by the Finance Minister was suitable to the occasion, it needs to be added that the relationship between currency in circulation and inflation is not as simple as it is generally perceived.
Firstly, it is not only the currency in circulation but overall money supply including bank deposits that determines effective demand in the economy. Secondly, change in money supply, and currency in circulation is a substantial part of this, affects the rate of inflation with a time lag which, in Pakistan, is estimated to be around one year or so. And thirdly, although the impact of money supply on price level is quite pervasive, other factors like the prices of imports, particularly of oil, and availabilities in the country measured by GNP also play a role in determining the inflation rate.
In any case, there should not be any doubt in anybody's mind that inflationary pressures would continue to jolt the economy if government's need to borrow from the State Bank is not reduced through revenue raising and expenditure cutting measures. It would, therefore, be good for the country if the legislators could seriously listen to the message indirectly conveyed to them by the Finance Minister and lower the level of their resistance to the actions contemplated by the government in this connection.