Advisor to the Prime Minister on Finance Dr Hafeez Sheikh expressed concern at the rate of inflation, and the credibility of Pakistan Bureau of Statistics (PBS) data while chairing a Monetary and Fiscal Policies Coordination Board (MFPCB) meeting held this Thursday past. Governor, State Bank of Pakistan (SBP), Dr Reza Baqir, an MFBCB member, responded that there was no pressure from the demand side, his area of responsibility, and recommended disaggregating inflation components to determine the exact contribution of each item to inflation.
Dr Baqir’s recommendation to disaggregate inflation is inexplicable as the PBS gives the weightage of each item in its calculation of the consumer price index (comprising of monthly price changes of 356 items in urban and rural areas), the sensitive price index (includes weekly price changes of 51 essential items) and core inflation (energy and food prices not included as the former is responsive to external market conditions including the rupee dollar parity which is within the SBP domain while food inflation is generally a seasonal supply side issue).
Inflation however is not only demand-pull but cost-push (utility/input costs rise as well as higher taxes impact on prices) and built-in indicating demand for higher wages as prices rise – all elements that were negotiated and agreed with the International Monetary Fund (IMF) by Dr Baqir and Dr Sheikh who have been formulating and implementing fiscal and monetary policies of this country for the past fifteen months; and sadly, like their predecessors, they are at pains to pass on the buck to a third party notably cartels which operate in even those sectors like sugar and cement whose prices the world over are set by market conditions (supply and demand). This evaluation has nicely fed into Prime Minister Imran Khan’s oft repeated mantra of mafias ruling the country. Dr Sheikh and Dr Baqir have also succeeded in deflecting the Prime Minister’s attention away from the fact that inflation during his administration’s first seven and a half months in power was lower than the rate during the next seventeen months: 6.5 percent in July-April 2018-19 against 11.2 percent in July-April 2019-20 (after the induction of the new economic team by the Prime Minister).
Notwithstanding the capacity and, equally if not more importantly, the direction by those in key executive positions to PBS to manipulate data to show a better performance than is the case the fact remains that inflation, unlike other macroeconomic indicators, responds pretty quickly to change in policy and fifteen months is long enough to control those inflation components that are impacting on the poor, the vulnerable and the average income households. Be that as it may, inflation as noted above is mainly due to the conditions and more importantly the pace of implementation of these conditions, upfront nearly all, that Dr Sheikh and Dr Baqir agreed with the IMF under the Extended Fund Facility (EFF) programme.
The conditions pertaining to the SBP policy decisions are twofold. First, linkage of discount rate not with core inflation which includes items responsive to the discount rate, which was 8.5 percent in March 2019, but to CPI which includes components that are not responsive to the discount rate. Dr Baqir pledged to the IMF team to raise the discount rate to 12.25 percent as a prior EFF condition in May 2019 and, raised it to 13.25 percent on 20 July 2019 (though it is unclear whether that decision was due to IMF pressure or not). This high rate led to a severe contraction of domestic productive activity (large scale manufacturing sector’s growth contracted by a whopping 10.2 percent last year with more than 4 to 5 percent tabulated before the pandemic) while there was a little over 3 billion dollars hot money inflows. Hot money as repeatedly pointed out to the Governor at the time but to no avail, is no longer considered a desired source for strengthening foreign exchange reserves as it can leave the country over night. Not surprisingly, it has left the country since.
Today the discount rate is 7 percent though the sensitive price index year on year was estimated at 8.7 percent and the core inflation at 5.6 percent in August 2020. In other words, the rate is neither linked to CPI, no doubt considerable political pressure may have prompted the Governor to abandon his earlier insistence on linking the rate to the CPI; but at the same time SBP resisted the move to lower the rate by linking it to core inflation as in the pre-Baqir era. This position too may change if the Prime Minister gives Dr Baqir an ultimatum.
Second, a market-determined exchange rate which the IMF argued would “help the functioning of the financial sector and contribute to a better resource allocation in the economy.” True indeed, however with the SBP now claiming that its calculation of the real effective exchange rate (REER) mechanism is a medium- to long-term exercise there is no longer any indicator available to it to ensure that the rupee is not undervalued. Former SBP governors, however, maintain that the REER calculated by the SBP and still uploaded on its website indicates that it is undervalued to the tune of a little under 7 rupees today. Each rupee undervaluation raises debt by 100 billion rupees with a consequent impact on the fiscal deficit which in turn impacts on inflation. And the impact of an undervalued rupee on imports of raw materials by the private productive sectors and its consequent impact on exports has been patently evident.
The Finance Ministry’s policy decisions have also impacted on the rate of inflation. The obvious contribution of tightening fiscal policy proposed by the IMF by setting the unrealistic target of 5.5 trillion rupees for last year that was agreed to by Dr Sheikh was premised on widening the tax net; however to date Dr Sheikh’s focus appears to be on changing the Chairpersons of Federal Board of Revenue (Pakistan is onto its third chairman in fifteen months with the incumbent not confirmed at his job) and failure to widen the net has led to higher taxes on existing tax payers further throttling the wheels of productivity, raising the numbers of unemployed and eroding the purchasing power of the salaried class. In addition, the performance of the energy sector remains poor, the circular debt continues to rise and is at present estimated at 2.2 trillion rupees – a rise of one trillion rupees in just two years – which accounts for the steady rise in tariffs as per conditions agreed with the IMF.
And finally, by getting the IMF to agree to focus on primary deficit of 0.6 percent of GDP Sheikh then proceeded to raise debt – domestic debt rose by over 7 trillion rupees in just two years and foreign debt was envisaged to rise by 38.6 billion dollars in just thirty nine months of the IMF programme (not including the additional 2 billion dollars borrowed to deal with the pandemic). With a budget deficit of over 9.1 percent inflation has been fuelled and keeping public sector salaries constant this year has impacted more on their quality of life than is evident from the rate of inflation.
To conclude, it is extremely worrying for the general public that economic policymakers continue to pass on the buck to a third party instead of acknowledging their own contribution to inflation and undertaking remedial measures.
Copyright Business Recorder, 2020
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