It would not be out of place to state that a smaller group of economists in the community in these forums also subscribe to the notion that it will be more effective to first reduce the annual tax expenditures estimated to be between PKR 1.5-2 trillion per annum, which mostly goes to the elite class and increasing tax/GDP ratio is a secondary issue.
This may increase the efficiency and productivity of the economy and may in fact increase tax collection. Lately, IMF/WB in addition to the above diktat, is also supporting the first half of the above notion, though belatedly.
Even, if the subsidy bill of PKR.1 trillion (FY23-24 estimate) out of the above tax expenditures is reduced to zero at a stroke of pen following Argentina’s example, the fiscal gap between net revenue receipts and current expenditure is so wide (budget estimate FY23-24) and the former can only finance 52 percent of the latter, just because interest payments constitute 105 percent of the former.
An anatomy of economic clichés/mantras of 2023—I
In the above scenario, further cut in remaining current/development expenditure (excluding defense expenditures) will not dent the bloated fiscal deficit. No doubt the economy is living on borrowed times.
Thus there is no way except to expand the I-Tax base (not pseudo direct taxes or further contamination of I-tax), on a war footing.
Anti-Washington Consensus (AWC) economist and pro-growth businessman lobby, although a minority in these forums, sang the mantra of reducing interest rates. The anti-monetarist/IMF lobby’s stance is that the current 18-month inflation episode in Pakistan is solely a supply-side phenomenon because of transmission through administrative prices, depreciation of the currency on imports and working of law of ‘one price’ on exports. Increase in interest rates only increases the debt-servicing cost, thereby increasing deficits and thus money in circulation and given that Pakistan is mostly cash/casino economy, fuels inflation.
No doubt increase in policy rate increases the debt servicing cost, but this is the cost the economy has to pay for committing economic sins (accumulating debt and running deficits) in the name of development and shallow growth in the past 30 years.
It was heartening to hear some of the gurus’ guilt in the forums that they have collectively failed the nation, by not restraining the political system from the debt or ‘death’ trap.
The relationship between interest rates and inflation is fairly technical, multidimensional and circular, and still remains to be researched empirically and therefore can be regarded as a cliché/mantra.
The most recent real-life example against the mantra is the U-turn by Turkeyi, from the unorthodox policy of low interest rates amidst high inflation to boost growth and stabilize currency.
After following it in 2021-22, Turkeyi finally started raising interest rates in Jun’23. It currently stands at 42%, (compared to 8.5% prior to U-turn) against an inflation rate of 61% coming down from 84% last year and record increase in foreign reserves since U-turn.
Though the economy of Turkeyi is not directly comparable to Pakistan, as it is more reliant on foreign flows from the Middle East, it still weakens the mantra. Empirically and theoretically, there is a lot of uncovered ground in declaring unambiguously that increase in policy rate has no impact or even increases inflation in Pakistan.
Some of the holes that exist in the speeches in the above forums were: Empirically are we talking about core or CPI inflation, as both may have a different impact of changing interest rates? In relating interest rates to inflation are we talking about real or nominal interest rates? Do the extent of negativity or absolute level of nominal interest rates matter in influencing inflation rates? Isn’t measuring the impact on inflation more meaningful when one considers’ demand ‘relative’ to supply at short frequencies, i.e., monthly and or quarterly rather than just demand (GDP) and money supply, on yearly basis? Does the extent of negativity of interest rate impact inflation via speculative investment demand in lowering the demand for fungible credit for speculative/luxury imports (e.g., automobiles), hoarding of grains, fertilizers, cement thereby weakening the few levers of this casino/cash economy.
A live example is lower demand for automobiles since policy rate shot up to 22 percent. Keynesian do not in favour, as it reduces employment. What is the role of extent of negative interest rates on stabilising the currency and thereby the imported inflation rate? How do nominal interest rates impact inflationary adaptive/rational expectations? Does interest rate affect choice between consumption and casino type investment, e.g., USD, property, Gold, automobiles, stocks and real estate (all unproductive and/or import intensive) in the short to medium run in Pakistan? Interestingly, high interest rates failed to impact another lever of casino economy, namely stock market, witnessing dizzy heights since July’23.
Analysts attribute this boom to leverage buying, meaning financed by banks over loaded with idle deposits. In other words, it is still possible to play and profit in a casino from borrowed money at 22 percent.
The critics may argue that the observed relative stability (short/medium term) in exchange rate, is due to administrative controls and not due to high interest rate, than the reason for inefficacy of monetary policy is on the structural weaknesses behind sustaining demand pressures.
These are high population growth, culture of smuggling (Afghanistan effect), nearly 100 percent increase in the rupee value of official and unofficial USD remittances (increasing/sustaining domestic demand and currency in circulation), with no offsetting increase in supply of goods, including surplus for official exports, rapid urbanization and restrictions on trade of vegetables and grains with India (affecting seasonal inflation).
Given bottlenecks in increasing supply in the short to medium run, Central Banks all over the world have little alternative than to rely on the impact of high interest rates to dampen inflationary expectations to equate rising/sustained aggregate demand, including speculative tendencies of economic agents, with given slow rising aggregate supply constrained by permanent(in our case) and un-predictive short to medium run structural supply bottlenecks.
So the simple lesson that applies to single household, that one cannot survive with household budgetary deficits for long and borrowing at usurious rates, is equally applicable to a country even with a printing machine.
Long live the previous generation of economist (including myself as a student) in search of shallow growth, employment and development.
(Concluded)
Copyright Business Recorder, 2024
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