Pakistan’s inflation conundrum: out of the frying pan into the fire

The pervading tale of Pakistan’s economic mess has become a grinding soap opera, replete with an out-of-touch storyline and no end in sight.

The latest inflation reading released earlier this month by the Pakistan Bureau of Statistics (PBS) only managed to add more pain to the chronic wound the Pakistan economy has lately become, after the country cemented its place with the highest inflation in Asia, surpassing that of defaulted Sri Lanka.

The Consumer Price Index (CPI) based inflation shattered new records in April to hit 36.4% higher from a year earlier, the highest since 1964.

Food CPI: hyperinflation not too far off

Delving deeper into the figures, the inflation was surprisingly more pronounced in rural areas, as it increased to nearly 41% on a year-on-year basis in April as compared to a 33.5% hike registered in the urban centres.

Another distressing development was the doubling of food inflation, a worrying sign for a low-income country like Pakistan, where millions of inhabitants live below the poverty line.

Pakistan’s CPI inflation reading in March clocks in at 35.4% YoY

Meanwhile, economic experts believe the worst is yet to come, and inflation readings are expected to cross 40% in coming months.

Even the Ministry of Finance in its latest monthly outlook report predicted that “headline inflation (CPI) is expected to remain at elevated level in the months to come as its key drivers are food and energy price hikes”.

Consumer price inflation in Pakistan second highest in South Asia: World Bank

Although inflation readings have remained in double-digits since November 2021, a significant spike was witnessed in June last year after CPI-based inflation crossed the 20% barrier and has continued to climb new heights.

Meanwhile, during the same period, the State Bank of Pakistan (SBP) has been quite liberal in jacking up the policy rate, a key tool used to curtail inflation, which has risen from 8.75% in November 2021 to 21%, as announced by the central bank’s Monetary Policy Committee (MPC) last month.

However, the incessant increase in key interest rates has so far proven ineffective, which is evident by the untethered rise in inflation.

Further hike in policy rate on the cards as inflation runs deep in Pakistan

Even the government admitted the inability of the central bank’s policy rate tool.

“Although the SBP is enacting contractionary monetary policy, inflationary expectations are not settling down,” read the Ministry of Finance in its Monthly Outlook report for April.

The country’s corporate sector also has been vocal in expressing its dissatisfaction with the continuous policy rate hike and its resounding effect on businesses and the economy at large.

“Higher policy rate is not an effective solution for cost-push, devaluation-led inflation in Pakistan,” stated Pakistan Business Council (PBC), the country’s largest private sector advocacy forum, in a tweet post this week.

“The 21% current rate is already a burden on the formal sector and targeted actions to depress demand, including the import crunch are in place,” the PBC added.

Inflation to remain high despite policy rate hike: analyst

The PBC statement coincides with the recently announced financial results of listed companies where the impact of interest rate hikes is quite visible. The corporate world has witnessed a significant rise in its financing costs, which has dented its bottom line.

So the question remains, what can be done?

We need to understand that the effectiveness of increasing interest rates as a tool to control inflation depends on a variety of factors, including the level of inflation, state of the economy, and the behaviour of consumers and businesses.

In Pakistan’s case, supply-chain disruptions caused due to recent floods, global economic challenges and more importantly, the government’s restrictions on opening Letters of Credit have played a major role in driving up inflation.

The government’s action to restrict imports, taken to curtail the outflow of precious foreign exchange, may have bought the bulging current account deficit under control.

All this has come at a heavy cost – bringing the national industrial activity to a standstill, a trend that has become evident with a string of companies announcing complete or partial shutdowns, and also creating a supply shortage in the market, which has driven up rates of goods.

The price of items considered necessities including medicines and poultry has skyrocketed owing to an unavailability of essential raw materials.

In Pakistan, there is a ‘Game of Thrones’ no one wants to see

Companies also resort to hoarding in such volatile circumstances and this only worsens the availability of products. Thus, one needs to resolve supply chain issues. Unfortunately, this cannot be taken care of through interest rate hikes. It needs to be fixed through administrative measures.

Measures such as the normalisation of imports can play a major part, as the supply situation would improve considerably, driving the rates downward in the market.

However, to achieve this the government needs to improve its liquidity position, which despite the recent uptake of dollar inflows remains at a critically low level, therefore, curbing the recent rise of hawala and hundi could be one such measure.

A Hawala Tsunami?

Overseas workers should be incentivised by offering premium rates, making informal channels less lucrative. Meanwhile, dollars accumulated through remittance inflows could act as a cushion for the government as they ease import restrictions.

The improved liquidity position would also ease pressure on the local currency, which has sustained record depreciation against the US dollar.

High inflation badly hits Eid shopping

If this is achieved, the inflation rate could be controlled considerably.

The demand-crushing measures have already dented the public’s buying power, and this was on full display in the form of low buying witnessed during the Eid season, the impact of which would be seen in months ahead.

It is high time that businesses are allowed some space and demand is induced.

Pakistan’s crisis is a moral one — not an economic one

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