Reports have been surfacing recently alleging that the Government is seriously considering freezing the prices of essential commodities as well as electricity charges in the budget. There is little doubt that such stories fuel expectations within the general public and, in the likely event that the government may be unable to meet these expectations, a serious law and order situation may arise.
Coming in the wake of existing security issues facing us today the country can ill afford food riots as well. That it is highly likely that the government will be unable to meet expectations of freezing prices of essential items with an in-built element of subsidisation, given the resource constraints it has been grappling with in recent months, cannot be denied.
The decision of the former government as well as the Caretakers to heavily subsidise diesel oil price for political reasons, in the wake of the rise in the international price of oil, has led to an unprecedented rise in the budget deficit - 9.5 percent according to recent government estimates. Allowing the budget deficit to rise further - an obvious outcome of increased subsidisation - would be highly inflationary and must be resisted at all costs.
There is thus an urgent need to lower the budget deficit to reduce inflationary pressures. This can be done through either increasing revenue or decreasing expenditure. With a slow-down of the economy as reflected in the revised growth targets for the year, the revenue generating capacity of the government is likely to be compromised, if taxes remain the same.
Thus to increase revenue would require an increase in existing taxes or the imposition of new ones. Both these options will be resisted by pressure groups and, in turn, may have a negative impact on economic activity with a consequent impact on employment levels.
Expenditure, on the other hand, is unlikely to be curtailed given the major items under this head: defence, interest payment for past loans, Public Sector Development Programme (PSDP), and administration expenses which are likely to rise given the repeated claims by the federal government that wages would rise in the forthcoming budget. PSDP is the only item targeted to be slashed if recent reports are to be believed; however, the government's capacity to slash this is limited given that this is the measure of any government's commitment to the welfare of the people.
In this scenario it is highly likely that the government would be forced to place heavier reliance on foreign borrowing, largely procured at market interest rates, and/or deficit financing or borrowing from within. The former Finance Minister, Ishaq Dar and the Governor of the State Bank of Pakistan have already declared that they expect around 3 billion dollars worth of foreign assistance by end June this year - an amount that would be used to plug the budget deficit.
This figure of expected foreign remittance comprises one billion dollars in outstanding payments by the US for services rendered in the war against terrorism, $500 million each from the Asian Development Bank and the World Bank, and about $640 million on account of 15% of MCB Bank shares bought by the Maybank of Malaysia.
At the same time, the Governor of the State Bank has repeatedly warned the government not to rely on deficit financing as this is a highly inflationary policy. In other words, it is imperative for the government to control the budget deficit through employing fiscal and monetary policy tools available in an effort to combat inflation.
Statistics released recently indicate that the country is in the throes of serious inflationary pressures. According to the Federal Bureau of Statistics the Consumer Price Index consisting of 32 essential items rose by a hefty 26.55 percent in the week ending May 15, 2008. No one can deny that such a rate rise requires urgent remedial measures.
The price rise of essential commodities can be dealt with through increasing imports, whether the rise is due to an artificial shortage, courtesy the overactive hoarders' and smugglers in this country, or to a real supply shortage due to lower production in any given year.
In the case of wheat and rice, our staples, the problem arose due to flawed estimates that provided an opportunity to the smugglers and hoarders operating in the sector. The Government's approach was to stop the profiteers through decree.
However this policy met with limited success with the Government unable to fully implement policies targeted towards the hoarders and smugglers. This realisation may have led Prime Minister Gilani to order the import of 2.5 million tons of wheat, which would take away the incentive of the hoarders and the smugglers. To give an across the board subsidy may not be feasible from an economic point of view. However targeted subsidies must be considered - targeted to the very poor.