The Consumer Price Index (CPI) for October 2024 was 7.2 percent against 6.9 percent the month before – a rise of 0.3 percent which, barring June 2024 when it rose by 0.8 percent against the previous month, shows a consistent monthly downward trend from December 2023 at 29.7 percent till to-date — a 22.5 plummet.
In contrast, core inflation (non-food and non-energy as their price is too volatile) declined in October 2024 to 8.6 percent from 9.3 percent in September and from December 2023’s 18.2 percent – 8.9 percent decline, not as steep as the CPI.
Governments routinely manipulate CPI and core inflation; however, manipulation is at best no more than say 3 to 4 percent and therefore the downward trend is undeniable.
A decline in CPI, inclusive of imported inflation, has a positive political fallout; and its decline, amongst other factors, has been on the back of a stable rupee-dollar parity since September 2023 – a stability that was achieved subsequent to the stakeholders initiating and enforcing administrative measures against hoarders, black marketeers and smugglers of dollars with strict orders issued against unauthorised money changers and other mafia.
However, the day after Trump’s election win all major currencies of the world plummeted against the dollar, with the Pakistani rupee sustaining its value. This strengthened the perception that the rupee-dollar parity is being controlled through administrative measures, including a delay in opening of letters of credit with the Staff Level Agreement (SLA) on the 7 billion-dollar Extended Fund facility uploaded on the International Monetary Fund (IMF) website last month, noting that “the authorities viewed maintaining the shortening of the period for repatriation of export proceeds as appropriate given still fragile external conditions.”
A reduction in core inflation lays the groundwork for a reduction in the discount rate, barring the tenure of Reza Baqir as Governor, State Bank of Pakistan (SBP), when it was untenably linked to CPI at IMF’s insistence. Core inflation is thus again being used to adjust the discount rate by the Monetary Policy Committee (MPC), under the chairmanship of Governor SBP, who is a signatory to all agreements with the IMF which, in turn, has a direct impact on the cost of borrowing for the private sector as well as the government.
The SLA further notes that “the balance sheets of the three parties, the sovereign (government), commercial banks, and the central bank have become highly interconnected. This complex tripartite relationship means that developments or actions in one domain (e.g., fiscal, monetary policy and the banking sector) can have wide-ranging effects across the economy. It also significantly affects the strength of monetary policy transmission by impinging the relationship between policy rates, private credit, and, private investment and consumption decisions.”
In other words, a reduction in the discount rate is likely to reduce the debt servicing costs of the government with little prospect of a rise in credit to the private sector (which explains why credit to private sector was negative 240 billion rupees 1 July to 11 October 2024 as per the Finance Division); however, with administration after administration exceeding its budgeted expenditures (mainly current expenditures not backed by any rise in output) the budgeted deficits have been exceeding sustainable levels — a highly inflationary policy.
Since 2019 Extended Fund Facility (EFF) programme was approved, the IMF has insisted on a market-based exchange rate as a loan and tranche approval condition, defined not as a rate set by the market (supply and demand) for that is applicable only to the world’s major currencies, but as a managed float with no predetermined path for the exchange rate.
Be that as it may, the rate must be based on the implementation of monetary and exchange rate policies within the confines of an IMF-approved framework (in Pakistan’s case an interbank rate not deviating from the market by more than 1.25 percent) with established floors for international reserves (negative 12,050 billion rupees end December 2024) and ceiling for net domestic assets of the central bank (15,211 billion rupees end December 2024).
There is no inflation target agreed with the Fund under the ongoing programme, though the Staff Appraisal in the Staff Level Agreement (SLA) uploaded on the Fund website in October this year noted that “monetary policy should remain geared to reducing inflation toward the SBP’s target.
The authorities are committed to bringing core inflation down and re-anchoring inflation expectations. In this regard, policy rates will remain substantively positive in real terms and data-dependent to adjust quickly to evolving price dynamics. At the same time, to support monetary policy formation and implementation, the inflation expectation survey will be aligned with best practice.“
Two obvious observations are in order: (i) the policy rate remaining substantively positive in real terms — and accounts for a 15 percent discount rate when core inflation is 8.6 percent and CPI even lower at 7.2 percent; and (ii) inflation expectations survey be aligned with best practices no doubt a reference to the rather unrealistic claims by the MPC in its November 4 statement, maintaining that “the surveys conducted in October showed an improvement in confidence and a reduction in inflation expectations of both consumers and businesses” – an improvement that is not backed by anecdotal surveys carried out by Business Recorder.
In the letter of intent dated 11 September 2024 signed by Muhammad Aurangzeb, the Finance Minister, and Jameel Ahmed, Governor SBP, a prerequisite for Board approval of the programme, the two pledged, “tight monetary policy to re-anchor inflation expectations to continue the management of inflation down toward our target while cementing FX flexibility, continuing to rebuild international reserves, and maintaining financial stability” – salutary pledges that remain hostage to the failure of the government to reduce current expenditure, continue to pass on the onus of inefficient sectors to the general public through ever-rising tariffs, and a revenue target that is not realistic while foreign exchange reserves are mostly debt based.
Core inflation is a function of the heavy reliance on indirect taxes on services and goods, including withholding taxes levied in the sales tax mode but dishonestly credited under direct tax collections, much to the chagrin of domestic economists and the Auditor General of Pakistan.
There is an acknowledged need to amend the tax structure by shifting away from the existing 75 to 80 percent reliance on indirect taxes (whose incidence on the poor is greater than on the rich) and towards direct taxes which are based on the ability to pay principle.
Unfortunately, the revenue measures identified in the 2024-25 budget, approved by the Fund as a prior condition for the ongoing EFF, followed the same trend as in previous years: a rise in existing easy to collect taxes that include a higher income tax on the salaried as well as raising the rate of existing indirect taxes on a range of goods and services.
To conclude, these tax measures have further shrunk the disposable income of 93 percent of the total employed by the private sector in this country (particularly lower to middle income earners with incomes largely static since the onset of Covid-19 in 2020), thereby accounting for an abysmal 41 percent poverty level in this country.
And this in turn raises the ugly spectre of a restive public in months to come that would further compromise the implementability prospects of the incumbent economic leaders’ economic policies.
Copyright Business Recorder, 2024
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