SPIRALING INFLATION AND REDUCING OIL PRICES

SYED FAZL-E-HAIDER
Jan 19 - 25, 2009

The government has so far been unable to fully pass on the benefit of the recent significant reduction in oil price in the international market to the common men. The oil price had touched its historic high of $150 per barrel in the world market last September putting further inflationary pressure on the tumbling Pakistan economy. The costlier imports particularly the ballooning oil import bill forced the government to resort to heavy borrowing from the central bank. The rapid erosion of foreign currency reserves and weakening rupee against the dollar created further complications for the economic managers to meet the country's widening current account and fiscal deficits. Ultimately, the government was forced to sign a $7.6 billion deal with the International Monetary Fund (IMF) in November to stave off a balance of payment crisis, as its foreign-exchange reserves had shrunk 75 percent and donor countries declined to provide funds.

Worsening security situation on the border situation and pressure on revenue collection are identified as the key factors barring the government from taking crucial steps to relieve the inflation-hit masses. While the inflation is currently at 24 per cent, the core inflation is hovering around 19 per cent. Officials however hope that core inflation would come down soon, as the government has so far lowered petrol prices by more than 40 per cent, since oil prices in the international market started going down.

The major factors contributing to the rising inflation include demand-supply problems, excessive borrowing by the government and delayed but compulsory adjustment in oil prices. Poor agriculture performance is also considered a major factor behind the recent price spike, as it caused severe shortage of key commodities such as wheat flour, rice and cotton. The widening fiscal and current account deficits also continued to add to inflationary pressures. The country's oil import bill increased by 45.36 per cent to $5.482 billion during the first five months of the current fiscal year from $3.771 billion in same duration last year, according to the FBS. More than 30 per cent deprecation of the rupee has increased the cost of the country's imports despite the fact that the oil has lost more than 70 per cent of its value in the international market. The decline in the country's oil import bill in November occurred on the back of steep cuts in the quantity of both crude oil and petroleum products imported due to a dip in demand, since the economy is slowing down.

The core inflation was above 18 per cent which could be a bad sign for the economy as the further increase in policy discount rate was attached with the lowering of core inflation, according to a recent report of the State Bank of Pakistan. The core inflation at the end of December 2008, according to the report, was 18.8 per cent which was higher than the expectation of the government. The policy discount rate was increased by two per cent to 15 per cent as part of deal with the IMF. The government has already announced that the policy discount rate might go up if the core inflation did not come down. The 15 per cent policy discount rate has already increased the lending rates above 20 per cent by the commercial banks. The business community has vehemently flayed the government for the 2 percent increase in benchmark interest rate for the central bank.

The rising trade deficit, huge outflow and slow inflows further widened the country's current account deficit by 44 percent to $6.8 billion during first five months of current fiscal year as compared to same period of last fiscal year, according to the central bank. Experts believe that the continuing upward trend in the current account deficit may force the government to get new foreign loan to meet the requirement of the increasing foreign payments. The government has already received $3.1 billion as the first tranche of $7.6 billion stand-by loan from IMF to make the country's current account payments.

Pakistan economy has improved during the first quarter of the current fiscal year and some macro-economic indicators had shown strength after a steep fall in 2007-08, says central bank in its first quarterly (July-Sept) report. 'The sense of crisis gripping Pakistan's economy in the initial months of the financial year 2009 has visibly eased by November 2008, as the government moved to address the most immediate risks and entered into a macroeconomic stabilization programme to support medium-term reforms under the aegis of the IMF,' according to the report. The country's foreign exchange reserves rose by $3.6 billion on January 9 as compared to November 25, 2008. At present, reserves are estimated at $10 billion. The additional amount can be mainly attributed to the $3.1 billion first tranche released by IMF on November 26 and the remaining $500 million as 'other positive inflows'.

Last month, Standard & Poor's ratings services raised Pakistan's long-term sovereign credit ratings by one notch; to 'CCC+' for foreign currency while local currency rating has been retained at 'CCC+'. The rating has been raised after the country received first tranche of loan from the IMF. Pakistan's long-term outlook could be further improved if the country is able to meet the targets set by the IMF, according to the Singapore-based S&P's.

The spiraling inflation has been a black spot on the strong economic performance over the last few years. In 2006-07, the Consumer Price Index (CPI) turned out to be 7.8 percent, far above the government target of 6.5 percent. The recent spike in prices of essential food commodities mainly wheat, edible oil, rice etc. put additional inflationary pressure. Pakistan's high-growth episode of 2004 to 2007 was the result of a growth model based on misguided policies, pointed out Asian Development Bank (ADB) in its recent report titled, "An Analysis of Pakistan's Macroeconomic Situation and Prospects". The current account deficit, the report says, resulted from imports increasing faster than exports, which led to dependence on inflows of overseas remittances, FDI, portfolio investment and loans. Increased government spending, together with an increase in business confidence, crowded in the private sector, with investment running ahead of savings.