MENACE CANNOT BE CONTROLLED BY RAISING INTEREST RATE ALONE
SHABBIR H. KAZMI
Sep 29 - Oct 12, 2008
Lately, the central bank has been raising interest rate in an attempt to control inflation. However, it is on record that the policy has not helped in any significant manner but adversely affected fresh investment in the country. The economic stabilization package announced aims at removing subsidy on oil and gas, which is bound to increase cost of production as well as cost of doing business.
With the government setting out to progressively rationalize the oil subsidy by passing on higher prices to consumers and by reducing the subsidy between the full-cost producer price and tariffs charged for electricity, average inflation is projected to cross 20 per cent, as against the target of 11 per cent. On top of this the increase in procurement price of wheat will further jack up already high food inflation.
It is on record that the central bank increased the discount rate from 9.5 per cent in June 2007 to 13 per cent, yet the inflation has climbed. To achieve targeted 14 per cent increase in money supply, the government would need to have strict limits on budget access to SBP credit. Since the inflation in Pakistan is driven mostly by high commodity prices, monetary tightening is having limited impact on inflation and mostly aggravating other structural problems.
Excessive dependence on higher interest rates to stabilize price has made investors reluctant to use debt financing and therefore push them to rely more heavily on self-financing. Moreover, unless interest rates are raised significantly, it will probably take a long time for monetary policy to have an impact on the economy and inflation.
High inflation has curtailed purchasing power of public at large and adversely affected saving to GDP ratio. In fact many analysts are of the view that 'middle class' is vanishing fast as more and more people are pushed below the poverty line.
On of the reasons for higher GDP growth during Shaukat Aziz regime was demand pushed growth. Though, many of his critics did not like the policy, but it is a fact that during that period accelerated sale of cars, motor cycles and other consumer durables also helped the financial sector in achieving higher profit.
With the hike in interest rate sales of cars and motor cycles have reduced to half lately. Hike in interest rates is also responsible for delinquency and NPL. Not only those individuals are in trouble and are facing confiscation of their vehicles industrial borrowers are facing worst time. The manufacturers in general and exporters in particular are facing the brunt.
Sellers in the domestic market often succeed in passing on the hike in cost to consumers but exporters cannot do this. Governments of developing as well as developed countries offer incentives to agriculture, trade and industry to save the economy from adverse impact of hike in POL and food products. As against this the 'wiz kids' of Pakistan are getting ready to withdraw subsidies.
However, it is a separate debate whether the government is giving subsidies or not. To begin with the government is still collecting billions of Rupees taxes from POL and gas. It may not be wrong to say that the 'pricing formula' does not disclose a number of levies which have been made integral part of cost of product.
It is also propagated that the government is giving billions of rupees subsidy on fertilizer. On the outset it is incorrect to say that government gives subsidy on gas sold to fertilizer manufacturers. In fact it is sale of low quality gas at a discounted price.
As regards subsidy on imported fertilizer, it is the result of bad policy. The wiz kids insisted that the government should not agree to a long-term price agreement with the sponsors of upcoming projects but never realized what could be the quantum of impact in case fertilizer prices go up in the international markets.
Local manufacturers are selling urea around US$150/ton whereas the commodity is being sold around US$850/ton in the international markets. During 2008 the country faces shortage of 500,000 tons of urea alone. This translates into an erosion of around half a billion dollars from already depleting foreign exchange reserves of the country. Only an insane person could endorse such a policy because ample gas is available from Mari gas field, which the government had dedicated for the fertilizer industry as back as in 2001.
Similar is the case with wheat because locally produced quantity is more than enough for the domestic market. Boarder forces have not been able to check its move to Afghanistan and India. Lately, Pakistan was asked to export wheat to Afghanistan because it was facing acute shortage of wheat. However, one failed to understand why Pakistan did not get the support from countries who have pledged billions of dollars for Afghanistan.
The real point of concern is that import bill of the country is on the rise because of emerging shortage of wheat, cotton, fertilizer and POL products. The quantum of import can be contained by stopping illicit move of fertilizer and wheat to neighboring countries. POL consumption, particularly furnace oil and high speed diesel can be curtailed by containing wastages and inefficiencies.
It could be said without any hesitation that this nation suffers because of two contentious issues extravaganza and inefficiency. The reason for budget deficit is lavish spending by the people in power. It is often said that this country suffers from acute shortage of electricity but hardly any effort is made to contain wastage.