The fact that inflation is rising almost everywhere suggests some of its causes are global. For now, rising food and energy prices are inflation's prime drivers. Core inflation, a measure that excludes volatile food and energy prices, is not rising as quickly as overall inflation. But commodity-price gains are beginning to work their way through the global economy.
Even if commodity prices stay where they are, global inflation could continue rising for months to come as companies react to previous price rises. High food and energy costs hit developing countries, including Pakistan, where consumers spend a larger share of income on those necessities.
Apparently the tattered economy has been hit hard due to deteriorating socio-political situations, war going on in the northern areas and rising inflation. The Consumer Price Index (CPI), that is the most relevant tool of measuring inflation of consumer goods, registered a drastic hike and increased by 25.33% over August 2007.
This outrageous inflationary behaviour is imposing detrimental high costs on our society and is severely hurting the poor 'common man' class that makes up a majority of our debilitating economy. Higher inflation has resulted in a spurt in interest rates and hit the car and other retail loans market, besides hampering the expansion and launch of projects planned by corporates.
The government is unable to reign in the surge in the inflation rate because the price of several other commodities like sugar and cotton has shot up. Along with the rising inflation, the rupee continues to depreciate against the US dollar. The weakening rupee is pushing up prices of imports, ricocheting 'cost increase' impact right down to the final consumer that is already burdened up with ever increasing utility, fuel and food bills.
The story does not conclude in a dismal end here. Inflation, eroding away the purchasing power of masses and making financing dearer for corporates consequently reduces affordability. Low affordability threshold results in a sliding demand. Dropping demand curve means that companies' revenues get hit and they tend to offset it with cost saving/reduction initiatives and this fuels the nightmare of stock markets.
As Pakistan does not have any developed debt (bond) market, a huge proportion of investments make its way in the stock market. Given that our stock market is not governed by fundamentals but whims, fancies and herd mentality as shown many a time in the past, the hyper inflationary scenario wreaks havoc on investors. Inflation robs investors by raising prices with no corresponding increase in value.
One has to pay more for less and even that less a return, if there is any, needs to be paid back to institutions as margin call and eventually an investor, at the end of the day has to pay off from his own pocket and ultimately he breaks down and defaults. This is what happened with Karachi Stock Exchange (KSE) whereby stocks have lost over 45 per cent since January, including more than 12 per cent in just one week after the resignation of former President Pervez Musharraf.
The Board of KSE froze the floor of KSE 100 index at 9,144 points amid continued recession and unabated downslide at the stock market. Although such an action seems preposterous in an institution that supposedly has to run on the vagaries of free demand and supply notions. Yet in the wake of the current situation of Pakistan this was the best regulators could come up with.
Theory suggests that exchange rate management, coupled with restrictive monetary policy, are the twin objectives in the quest for combating inflation in a hyper inflationary economy. This is exactly what the State Bank of Pakistan (SBP) has been doing. But is it going to work in the case of Pakistan?
There is a serious doubt about it because the government is one of the key borrowers to fund its alarmingly widening budget deficit and finance its import bill of oil on the back of ever weakening rupee.
SBP has raised the discount rate to 13.00% which will make financing dearer for government and eventually will be borne by the public in the form of taxes and surcharges or if the government tries to save the people from this burden, it will resort to printing new money and both these measure will further erode the purchasing power of the public and result in further inflation.
The only solution that appears feasible is that along with the tight stance of SBP measures monitoring the demand side, the government should try to take measures to enhance the supply of the of the products in order to effectively and collectively combat this vicious circle, else it will go on and on and any single sided steps will further fuel its ferocity.