ARTICLE: Aggregate demand must be curtailed to contain the rate of inflation, a theory fully supported by the International Monetary Fund (IMF) in its Extended Fund Facility (EFF) programme design, and agreed by the then newly-appointed Pakistan's economic team leaders - Dr Hafeez Sheikh appointed on 20 April 2019 as Prime Minister's Advisor on Finance and Dr Reza Baqir on 6 May 2019 as Governor State Bank of Pakistan.
The staff level agreement with the Fund was reached on 12 May 2019 with a range of prior conditions focusing on reducing aggregate demand (high discount rate, market based exchange rate that amongst other items also curtailed imports of raw material and semi-finished products with a consequent negative impact on manufacturing output and high taxes that no one other than Pakistan's newly appointed team leaders found realistic) while the programme's effectivity (including the release of the first tranche) began on 1 July 2019.
Economic Survey 2019-20 was presented by Dr Hafeez Sheikh on 11 June 2020, a day before the budget was announced this year as is the norm, which should indicate his ownership of the document. It noted that consumer price index (CPI) was 6.5 percent on average (July-April 2018-19) and 11.2 percent (July-April 2019-20). In other words, inflation rose dramatically subsequent to going on the IMF programme. It is disturbing that the highly qualified economic team leaders did not bother to query the Fund as to why the inflation rate would rise when the aggregate demand was projected to decline. By January 2020, inflation was estimated at 14.6 percent, declining to 12.4 percent in February - pre-Covid19. Thus one may conclude that the policies accepted by Pakistan's two team leaders designed to bring inflation down had not only the opposite effect but was also projected to have the opposite effect. The economic team leaders would have the public believe that the rise in prices can all be laid at the doorstep of what they refer to as supply side factors (more precisely on cartelization) and post-March 2020 on the pandemic which contracted aggregate demand by even more than was envisaged in the aftermath of the monetary and fiscal contractionary policies due to the lockdown (partial, smart or with the public flouting the standard operating procedures notwithstanding); however their arguments can be easily challenged given that the IMF projection for the first year of the programme, apishly part of the budget for 2019-20, included an inflation rate of 13 percent.
But severely restrictive fiscal and monetary policies are not the only factors impacting on inflation. Massive rise in government borrowing also contributed to the high inflationary pressures - borrowing from (i) external sources - projected at 38.6 billion dollars by Prime Minister Imran Khan's economic team for only thirty nine months (the duration of the Fund programme) in documents uploaded on the IMF website with an additional 2 billion dollars post-Covid19); and (ii) domestic sources - rising from 3.2 trillion rupees in 2008 to 9.5 trillion rupees in 2013 to 16.4 trillion rupees in 2018 to a whopping 23.5 trillion rupees on 20 May 2020. This crowded out private sector borrowing though the private sector was not willing to borrow given the discount rate of 13.25 percent in any case. Inexplicably, the government raised reliance on long-term borrowing such as on Pakistan Investment Bonds - from 3.4 trillion rupees in 2018 to 12.2 trillion rupees till March 2020, a rise of 259 percent - when the rate was as high as 13.25 percent. On 15 April 2020, PIBs issued amounted to about 128.6 billion rupees, on 28 May to 344 billion rupees and 24 June to 114.5 billion rupees as per the State Bank of Pakistan website.
This unprecedented massive rise in borrowing which raised the budget deficit to 9.1 percent (acknowledged by the government in the budget but which in all probability will be revised upward to 11 percent when the actual data is available) while on an IMF programme can be attributed to the success of the economic team leaders in focusing IMF attention away from the budget deficit like in the past, and instead to focus on the primary deficit (which excludes debt repayments and interest as and when due) - clearly a programme design flaw. It is gratifying that the Fund is reportedly focusing on the budget deficit target as a condition for the next tranche release however this would be confirmed as and when the IMF releases the second staff level agreement report, a precondition for the second tranche release. Queries from a handful of Finance Ministry officials surrounding Dr Hafeez Sheikh who have information on when talks with the Fund would resume on the second tranche release have elicited no definitive response clearly indicating the lack of an agreement.
Be that as it may, the economic team leaders have succeeded in focusing the Prime Minister's attention exclusively on supply side issues, with cartels held responsible for a raise in price of sugar, wheat and more recently cement (notwithstanding the reduction in excise duty on cement in the budget 2020-21). A change of the guard in Competition Commission of Pakistan is unlikely to resolve the supply side issues sourced to cartels unless the Commission is strengthened, adequate resources made available to it and last but not least stay orders vigorously contested in the courts. In addition, the raise in the prices of petrol and products can not be justified on the grounds that: (i) its pass through rather than adjusting the 30 rupee per litre petroleum levy and an additional 17 percent sales tax (implying taxes of about 47 rupees out of per litre price of 100 rupees), and (ii) citing regional per litre prices without taking account of other input costs that are much lower in neighbouring countries than in Pakistan making our products uncompetitive.
The pandemic hit the country in March and the remaining months of the fiscal year (30 June 2020) led to a further significant contraction of aggregate demand with nearly all sales impacted other than essentials, particularly food items. Growth went into the negative realm and the economic team leaders informed the Prime Minister that the pandemic was having a negative impact on the global economy and had Pakistan not had to deal with the virus their policies would have borne greater fruit and yet again cited the shriveling current account deficit as proof positive of the gains. Sadly the Prime Minister did not dwell on the cost associated with this particular gain on the economy and on the poor and vulnerable - had he done so he would have asked them for a cost benefit analysis of their policies. And given that the pandemic is fast eroding the gains in the balance of payment position reliance on borrowing may increase further rather than decline.
But back to inflation rate: the IMF website indicates inflation rates have come down post-pandemic in the UK, 1.2 percent, US 0.6 percent, Canada 0.6 percent, Denmark 0.7 percent, France and Germany 0.3 percent. The European Union registered a 0.6 percent inflation rate while advanced economies registered an average of 0.5 percent. Contrast these rates with Pakistan's 11.1 percent for the entire year. This would no doubt prompt the Prime Minister and his economic team leaders to mention the futility of comparing our data with those of advanced countries. Fair enough. Afghanistan's inflation rate was 4.7 percent, India's 3.3 percent, Sri Lanka's 4.7 percent, Bhutan's 3.1 percent and Maldives 1.5 percent. The South Asian average was 4.2 percent.
To conclude, the cabinet would do well to realize that the present-day Pakistan no longer compares favourably with regional countries. And the ones responsible are not only the cartels or the appallingly poor performance of the tax and power sectors, to just name two, but also the policies supported by the country's two economic team leaders.
Copyright Business Recorder, 2020
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