Stagflation is a situation when economic growth is stagnating, and inflation is also increasing. Growth requires increase in domestic production, which, in turn, needs investment. It is only the second time in this decade – which is closing on its halfway mark – that policy rate has decreased when it has been quite evident that inflation in net-oil importing developing countries like Pakistan, have a significant supply-side, governance related determination of inflation, whereby cost-push-, and imported inflation remains highly relevant in overall inflationary built-up.
Hence, there is a need for reaching a healthy balance between demand- and supply-side policy emphasis, something which the announced federal budget does not reflect, both in terms of underlying austerity-based policy framework on which it is built, and also the neoliberal, procyclical policy direction it takes.
Unfortunately, even after practice of over-board austerity policies and, in turn, giving a deep economic growth sacrifice, the government needed to learn from this wrong policy, given inflation remained stubborn and only started to come down at the back of both choking of economic activity on one hand – as evidenced from high policy rate policy, and administrative measures curtailing imports, and keeping investment low – and through practice of over-board monetary, and fiscal austerity policies squeezing fiscal space through high interest payments, and by strongly emphasizing moving towards, and maintaining primary surplus, on the other.
The extent of depth of practice of austerity policies could be seen, for instance, that as a recent Bloomberg published article ‘Pakistan cuts interest rate for the first time in four years’ pointed out that policy rate has been slashed after a number of years, not to mention that for almost the last two years it was kept at a whopping 22 percent, and only to be reduced by 150 basis points recently.
The article pointed out in this regard: ‘Pakistan’s central bank lowered its benchmark rate by a bigger margin than expected, the first reduction in four years, after consumer prices eased in the South Asian nation.’
Rather than budgeting a low amount for interest payments at the back of better realization by State Bank of Pakistan (SBP) that policy rate needed to be brought a little below double digit – given inflation has fallen a little under 12 percent – so that supply-side emphasis could be center-staged for reducing cost-push, and imported inflationary channels, the federal government has kept 56.8 percent of current expenditures for servicing interest payments, indicating, in turn, that policy rate reduction will be slow and likely come with shallow cuts.
This means that high cost of capital will not allow unlocking economic growth, and it will also feed into cost-push inflation; in turn, once again contributing to inflationary pressures. Also, lack of domestic production would also mean lesser exports, and together with high external debt repayment – around $12 billion over the next fiscal year, even if most of the other $12 billion of debt repayments over the same time, and owed to bilaterals, including China, and Saudi Arabia, likely to roll them over – means significant downward thrust on build-up of foreign exchange reserves and, in turn, greater pressure on domestic currency against the dollar. Hence, this would mean that in addition to greater cost-push inflation, imported inflationary channel will also likely pick up pace.
In addition to the federal budget for the upcoming fiscal year, being based on over-board austerity policy direction, likely to dent economic growth prospects, and also cause reversal of downward trend of inflation, continuation of emphasis primarily on regressive taxation, in the shape of increase in indirect taxation rate, including increase in petroleum levy – Rs 20 per liter on petrol, and diesel, reportedly, for instance – rather than expanding tax base, will hurt domestic consumption, another driver of economic growth. Overall, lack of build-up of aggregate demand, will not incentivize enough increase in aggregate supply, by denting consumption, and investment incentivization.
An otherwise paltry economic growth rate target of 3.5 percent for the current fiscal year is likely to be missed by more than one percent to 2.4 percent, as per the recently released government’s Economic Survey at the back of over-board austerity policy, keeping a lopsided focus on controlling inflation through keeping high policy rate over the last two fiscal years or so, and not emphasizing enough much-needed aggregate supply-side boost.
What the upcoming budget needed to have was a strong non-austerity emphasis – sharp and deep cut in policy rate based on low budgeting of interest payments, and shifting from indirect taxation to greater direct tax progressivity, and broadening – so that not only cost-push and imported inflationary channels could be squeezed for avoiding second-round impetus to the currently falling inflation – not to mention a world significantly marked by climate change, likely ‘Pandemicene’ phenomenon, and conflict determined instability as strong potential upward risks to economic growth, and macroeconomic stability in individual countries –but also economic growth – targeted once again at a low level of 3.6 percent for the next fiscal year under the announced budget, given population growth rate is around two percent, and there is strong need for enhancing economic resilience, welfare related spending –could be meaningfully enhanced.
Copyright Business Recorder, 2024
The writer holds a PhD in Economics degree from the University of Barcelona, and has previously worked at the International Monetary Fund. His contact on ‘X’ (formerly ‘Twitter’) is @omerjaved7
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