- A wrong policy response
Pakistan saw one of the most aggressive monetary tightening in Asia since the start of 2018, yet inflation could not be reined in. But with inflation consistently rising to reach a high of 9.4% since the tightening began; it is obvious that there is in fact no strong negative correlation between policy rate and inflation.
At the same time, IMF (International Monetary Fund) in its latest World Economic Outlook (WEO) report has downgraded economic growth projections for Pakistan to 2.9 percent for the current year. According to the same report, the emerging and developing economies- including India, which is expected to continue with seven-plus percentage growth- remain the fastest growing countries; yet Pakistan is certainly far behind.
The above clearly indicates that persistence with tight monetary policy for long duration, even when inflation hardly responded to policy rate increases, has had a sharp negative bearing on economic growth; with similar lack of positive consequences for employment and poverty levels. Should the PM not take to task primarily the Governor of SBP (State Bank of Pakistan) and then the Finance Minister for not highlighting the obvious, and adopting a different policy response to tackling inflation? In a civilized country these two heads of economic authorities, respectively, would have resigned on their own, since they gave and persisted with such a lack of correct and pro-active policy response to inflation.
Just because some countries have been kind enough to send some foreign exchange cushion and some will come in support from multilaterals like IMF in the wake of a likely prospect of a programme to be negotiated soon, by no means indicate that the crisis is over
Resultantly, the country is suffering from stagflation- that is from both high levels of inflation and unemployment, on one hand, and low economic growth, on the other; where the unemployment is expected to rise further in the wake of such weak performance on the economic growth front. On top of this, the Finance Minister recently reportedly said that there was no more a crisis situation, stabilization had mostly taken place, and now the structural reform will be initiated. Just because some countries have been kind enough to send some foreign exchange cushion and some will come in support from multilaterals like IMF in the wake of a likely prospect of a programme to be negotiated soon, by no means indicate that the crisis is over.
For one, the tax target is being missed for some time now, fiscal deficit is rising, including the increase in the above two variables. Secondly, and more importantly, institutional and structural reforms of markets and firms were yet to be started in any meaningful way, which would have most likely dented inflationary pressures since given a developing country context. And lastly, for rationalizing prices, especially in commodity sectors like agriculture and industry- including the pharmaceuticals- needed introducing deeper governance and incentive structures reforms, along with shifting in major way from indirect to direct taxation. Will, then, such an irresponsible statement of the Finance Minister go unchecked by the PM? Is there no accountability for the misery that this policy mindset has brought for the masses in the shape of both high inflation, and lack of investment opportunities in the wake of high policy rate?
Moreover, what are the Ministry of Planning and its provincial departments doing in coming up with a research based policy response to improve the working of markets? Are the heads of these authorities mostly active while launching some flagship projects, while at the same time these authorities producing mostly some fancy development and project monitoring reports, medium term broad economic policy frameworks, or mostly irrelevant empirical analyses? Do similar questions not reveal themselves to the mind of our PM; or some political expediency pushes them at the back of his mind. It is time the PM should revisit his economic team, since the people are suffering immensely and there is a huge lack of policy response to tackle inflation.
The economic authorities should understand that inflation in a developing country is both a monetary and fiscal phenomena. Above all, undoing inflationary pressures require fixing market failures, undoing collusive practices, reducing information asymmetries, and providing correct taxation and incentive structures. For one, it makes sense for the government to establish a price commission which oversees an exhaustive effort to rationalize prices in both the real and financial sector markets.
Secondly, the PM rather than reportedly giving isolated tasks to CM Punjab- like rationalizing pharmaceutical prices in Punjab in a few days- should ask provincial chief ministers to support the price commission in terms of civil servants visiting commodity markets in each city, and playing their part in ensuring that effective micro-economic market level policy input and implementation strategy is evolved and contributed to the price commission, over the short to medium term. They should also highlight ways in which prices are artificially kept high at the sale stage, and suppressed (i.e. wages) for the labour class. Thirdly, a part of price commission should look into speculative practices involved in the real estate, stock exchange and foreign exchange markets. At the same time, the price commission should rationalize profits so that the prices are not overburdened with abnormally high profits. The government will have to think out of the box, and the above are a few recommendations in this regard.
For a considerable time now, there has been too much focus of the government, SBP and the IMF, for that matter, in curtailing aggregate demand to reduce inflation in the country. This has clearly back-fired in terms of high policy rates neither reducing inflation- given the developing country context- nor the long persistent policy rate hike allowing an otherwise very low investment levels to rise. A balance needs to be brought now, and therefore, a supply-side push is indeed long over-due. For that, the country needs a monetary and fiscal stimulus, while at the same time, a strategy as indicated above of rationalizing prices, needs to be adopted. Hence, government expenditures should be increased, while at the same time policy rate should be reduced. Inflation should instead be tackled through a) highly focused and aggressive governance and incentive structure policy, b) improved institutional functioning of markets, and c) shifting rather quickly from indirect to direct taxation. Moreover, reducing policy rate will also help reduce the huge burden of domestic debt, which is expected to rise all the more for both the government and the private buyer in the wake of the PM Housing Scheme.
In the medium term, the government should try to improve the status of exports, so that foreign exchange reserves could be enhanced considerably. At the same time, it should also introduce an import policy so that the composition of imports should be shifted towards areas that do not feed conspicuous consumption, but rather put the economic base on strong fundamentals. Both these policies combined, are expected over time, to improve the strength of Rupee, and in turn reduce the exchange rate inflation pass-through; an important source for rising inflationary pressures.
The approach of economic authorities needs to change quickly, since a lot of economic damage has been done already, primarily through rising inflation. The finance minister needs to have better approach in understanding the economic issues and in finding their solutions, since the current approach will, most likely, not allow negotiating an IMF programme that keeps a healthy balance between aggregate demand and supply policies; which, in the light of above discussion, is the need of the hour.