INTEMPERATE INFLATION

AROOJ ASGHAR (arooj.asghar@crosby.com)
Jan 07 - 13, 2008

The higher inflationary trend in Pakistan over the last few years has been the outcome of pressure that arises from the demand and supply sides. Strong economic growth has raised the income levels of various segments of the society. Improvement in quality of life and the rising level of income have strengthened the domestic demand whilst putting upward pressure on prices of essential commodities. While looking at the supply side, it appears that there are numerous factors which adversely affect the economics. 2007 saw various issues which range from shortage of wheat to cotton crisis and political turmoil. All in all this influenced the living conditions of the poor. The prices of other food items such as beef, mutton, chicken, milk etc also registered sharp increases owing to "sympathy effect" on the one hand and demand pressure on the other. One of the issues which Pakistan's economy faces is the sympathy effect i.e. few segments increase prices by following the trend in other segments.

Inflation during the first six months (July-December) of the current fiscal year is estimated at above 10% as against 9.3% in the same period last year. Food inflation is estimated at above 11% as against 9% in the same period last year. Non-food inflation at 9% is on higher side compared with 6.9% in the same period last year. The core inflation which excludes food and energy costs from the headline CPI, moved up and estimated at around 9% as against 7.0% in the same period last year. The expenditure on food items constitutes bulk of the monthly expenditure of the poor segment of the society. Sharp increases in the prices of some of the strategic food items have put pressure on the poor.

In order to keep the prices of essential commodities under control, the government has been taking various measures (unsuccessfully) throughout the year. These measures include; a liberal import regime for food items including zero rating of the imports of commodities. In order to provide relief to the low and fixed income groups, the government has been selling wheat flour and sugar through the outlets of the Utility Stores Corporation (USC) at much lower prices than the market. In order to augment supplies of essential commodities in shortest possible time and at lower freight charges, the government has also allowed the import of various items through land routes from neighboring countries. The role of the Trading Corporation of Pakistan (TCP) has been enhanced even though the role of TCP is much disputed and concerns have been shown on its role in such situations.

High rate of inflation especially food inflation is one of the few issues where government also agrees with the comments of independent economists and international agencies. In the month of Ramazan, food inflation rate was its highest level in last five years. As a matter of fact, Pakistan has agriculture based economy yet people had to buy expensive food items which shows serious mismanagement. The government had the advantage of a bumper wheat crop of 22.5 million tones in 2007. Although the move to export a part of the surplus to India was shot down, still the government could not hold down the prices because of excessive hoarding and profiteering.

The food inflation in Pakistan is now admitted to be higher than it is in other South Asian countries. Food inflation is in double digits for the last several months. A finance ministry report said the highest ever increase in food inflation in any month of the fiscal year 2007-08 was due to an extraordinary surge in demand, particularly for fruit, vegetables, milk, meat, poultry and cooking oil during Ramazan. This was neither the first Ramazan in Pakistan nor there was any sudden increase in population yet the demand increased. One can only say that this shows the shortage of supply which can be attributed due to the hoardings or shortfall in crop. What ever be the case, the poor people are paying the price. A sharp rise was also witnessed in wheat and flour prices, driven by extra-market forces. Although, the prices of wheat and flour declined lately, their contribution to inflation was already realized. Food inflation emerged as a major source of concern for the policy-makers in emerging Asia, including Pakistan. While major sources of inflation can be external there are internal factors too which can aggravate the inflation.

The price of wheat, which is the main diet of all and sundry and largest grain crop of the country, is increasing day by day and nobody has a clue as to when it is going to stabilize. When the issue first emerged in second half of 2007, both Federal and Punjab (being the biggest wheat grower) governments started accusing each other for this crisis. The problem seemed to have originated from the zeal of government authorities to propagate their achievements that were not in conformity with the reality. Though the estimates were stated to be provisional, everybody was made to believe that the wheat crop during 2006-07 (to be largely consumed in 2007-08) was exceptionally good and would be more than sufficient for the consumption requirements of the country. Because of shortage of wheat, Pakistan is importing one million tons of wheat from Russia at an estimated cost of US $510 million to meet the domestic demand. The worst part of the story is that this import could be avoided by adopting proactive approach. Further the wrong policies regarding the support price of wheat and cultivation, production and management of the crop is also contributing in the crisis like situation. With every passing day, wheat issue in Pakistan is worsening instead of improving. The government goes for import of one million tons of wheat at a high price, paying a high freight and arranging for its local distribution. After adding the freight bill and local charges, the consumers are paying much higher price than what they would have been paying otherwise. This high cost of import of wheat and subsidy by government would push up the expenditure budget and further enlarge budget deficit. The belated decision of the government to import one million tons of wheat was a sincere effort to resolve the crisis but it was a partial solution.

In recent months, prices of various kinds of pulses also registered sharp increase owing to a significant decline in domestic production as well as shortages in international markets. This inadvertently kept the prices of pulses at record high level. An unprecedented rise in international oil prices also contributed to the build up in inflationary pressure in Pakistan.

Though there are few internal factors as well but lower production of sugar due to a relatively lower production of sugarcane and a sharp increase in the international prices of sugar brought about by a significant diversion of sugarcane into ethanol (petroleum substitute) also contributed in building inflationary pressure in Pakistan.

Several supply side and demand side factors are responsible for this surge in inflation. Inflation is a result of shocks to the supply of certain food items and to world oil markets. Rising oil prices is posing a continuous risk of rise in prices of almost all other commodities of consumer basket. Though government has not yet increased the oil prices and is subsidizing it but that day is not far away when OGRA will increase the oil prices. Once the oil prices increase, prices of every big and small item will automatically increase. Supply-side shocks are always very volatile and cause large fluctuations in food and oil prices, the effects of which on overall inflation at times are so excessive that these cannot be countered through demand management, including monetary policy.

It has become a common practice these days that all issues are correlated to the 9/11 incident. It's reasonably true that Pakistanis have remitted huge amounts after 9/11 whereas Middle East investor has also given preference to Pakistan for investment both in capital market and projects. With other factors along with these, huge inflow of money has increased the quality of life of people of Pakistan and money circulation has increased manifolds. Growth in private consumption remained above 10% on average depicting signs of demand side pressures on price level.

There is also a growing gap between domestic demand and domestic production which is filled by a sharp increase in imports. Continuous rise in trade deficit is another cause of high inflation. There are a few issues which are not controlled by monetary polices or by issuance of Presidential Ordinances, those needs management, where Pakistan is lacking the most. There is a danger that the current high rate of inflation, whatever is its cause, can hamper the conditions of the people and ultimately lead certain people to corruption. It wouldn't be wrong to say that non-availability of food can also motivate people to indulge in non-productive activities which will only damage society in many different ways.

Summing up, second half of 2007 was full of political turbulence which now seems to protract. Rumors are around that like 2007 this year will also be at the verge of an even critical wheat crisis. This threat can materialize if certain issues are not addressed and polices not implemented productively. For how long tax payers money will be used to subsidize such products unnecessarily and shielding the people behind such issues. Such protection is surely not given by one person but is allowed by the whole society. This attitude drains foreign exchange reserves of the country and ultimately poor people pay the price. This can be safely pronounced that the expansionary monetary policy though did contribute in promising GDP growth it also led to the rise in consumer prices. Particularly the phenomenal growth in the flow of "loose credit" to the private sector had a significant role to play in disturbing the price mechanism. It is always easy to say that there was mismanagement in any crisis but the real issue is what we have learnt from our past mistakes. It is not always necessary that we keep on referring similar issues from our history and continue to give shut up call to all. Obviously NO, there should be an end to this laxity and slackness. Food inflation is nothing but a mismanagement which must be rectified and addressed first.