SADAF AURANGZAIB, Senior Correspondent
Jan 29 - Feb 04, 2007

PAGE: What are the main causes of inflation? What supply and demand factors are responsible for this surge in inflation?

MA: At the outset, I would straightaway state that inflation poses a real threat to the economy with greater adverse impact on low income groups. The government had set a 6.5% inflation target for the current fiscal year as against 7.9% during FY 2005-06. However, as latest data indicate, the average increase in Consumer Price Index (CPI) during the first half of FY 2006-7 was 8.4%.

Inflation in Pakistan embodies both demand-pull and supply-push components. For a better understanding of the current inflationary situation, we should distinguish between headline CPI and core-inflation - as measured by non-food non-energy inflation. While headline CPI inflation during FY 2005-06 was 7.9%, the core (i.e. non-food, non-energy) inflation remained lower and was 6.3% in June 2006.

The sharp increase in oil prices and food supply side shocks were prominent in increasing headline inflation. The core-inflation (i.e. non-food, non-energy inflation) generally represents the persistent component of demand-pull inflation and was kept in check somewhat thru demand management policies adopted during 2005-06.

PAGE: How do you define the relationship between economic growth and inflation? Unless we expand our productive capacity to meet the growing demand, how is it possible to curb the inflationary pressures in long run?

MA: Economic growth through backward and forward linkages and the ensuing higher incomes certainly cast impact on prices. There is a gestation period before productive capacity comes on full throttle and starts delivering the required goods and services. There may also be a disparity between demand and supply of products, especially wage goods (notably food items). Nonetheless, the inflation rate of 8-9% with 6.6% GDP growth is certainly on the higher side.

PAGE: It is said that the rising trade deficit is another cause of high inflation as the growing demand is met by the increase in imports which is furthering the trade deficit. How do you see this condition?

MA: There is a nexus of rising trade deficit and higher inflation. Substantial increase in international oil prices and other commodities not only put pressure on our trade balance and our real economic growth, but also accelerate inflation. There was sharp escalation in inflation due to 75% increase in imports of petroleum and petroleum products from $ 3.8 billion to $ 6.7 billion, and of other food items. Consequently, Pakistan recorded its highest ever trade deficit of $ 8.4 billion during FY 06. The State Bank Monetary Policy Statement released recently acknowledges that the inflation in Pakistan is relatively higher compared to its competitors and trading partners.

PAGE: How do you see the government's expansionary fiscal policy which is also contributing towards rising inflation?

MA: Yes, the government is following an expansionary fiscal policy. The budget for FY 07 envisages allocation of Rs 435 billion for public sector development, especially for physical and infrastructure expansion. The major problem, however, is posed by over-dependence of the government on State Bank for budgetary borrowings, something that should be kept in control. As it is, there is divergence in government's expansionary fiscal policy and State Bank's tight monetary policy.

PAGE: Rising import prices and indirect taxation also do have a negative contribution to inflation? What is your view on that?

MA: Certainly, rising import prices and indirect taxes have inflationary impact. Almost 87% of the increase in the petroleum group imports during FY-06 was caused by high oil prices that were passed on to the consumers. Similarly, indirect taxes like sales tax, custom duties, surcharges on oil, gas and electricity etc., also added to inflation. Even withholding income tax, which is classified as direct tax, is in effect an indirect tax.

PAGE: What measures do you suggest to improve the export growth to maintain the balance of trade?

MA: We should seek market access to US, EU and other countries through FTA, GSP Plus, etc. We should have incentive-based packages comparable to our competitors who are two steps ahead in providing hidden subsidies, duty free import facilities, duty drawback schemes, cheaper utilities, subsidized interest rates, etc. We need to induct latest technologies for increasing export of medium and high technology products.

The cost of doing business is quite high. The rates of power and gas need to be rationalized. Power rates are substantially excessive, rates of natural gas at $ 4.02 per MMBTU for both captive power plant and industries are quite high, while gas rates in Bangladesh for captive power plants and industries are $ 1.9 and $ 2.65, respectively. The prevalent interest rates are excessive and formidably add to the cost of production.

Long Term Finance-Export Oriented Project (LTF-EOP), which provides financing facilities to exports and Export Refinance Scheme are helpful, but Export Refinance rate of 7.50% could be reduced.

PAGE: How do you think we can manage the domestic inflation that is growing day-by-day due to rise in high food prices?

MA: The government should try to improve supply situation, allowing immediate imports even from neighboring India, where necessary. It also calls for additional administrative measures to reduce food inflation. Mere reliance on utility stores, who cater to a limited number of people, is not the prime method of controlling food prices.

State Bank of Pakistan is following a tight monetary policy to reduce inflation but needs to do more to limit government's budgetary financing. As stated before, it should further reduce the interest rates as well as the Export Refinance rate.

PAGE: How do you see SBP's role in providing solutions for the rising inflationary pressures on our trade?

MA: SBP, according to Governor Dr Shamshad Akhter, does influence the rising inflationary pressures. The Monetary Policy has outlined its role in this regard. Of course, external factors, such as increase in oil rates, import of food commodities or natural vagaries are impacting the country's inflation rate - in fact on its economic development as well as poverty alleviation. By the way, the business community is still not able to understand the theory of the SBP Governor regarding the nominal and real interest rates. Just tell me, when I do my costing, do I take the nominal interest rate, say 13%, or do I take the real rate which is the real interest rate less than the inflation rate?

PAGE: What concerns do our trade bodies have regarding the current inflationary situation? And how do you see this trend in future?

MA: Generally, the trade associations and chambers do express their views on these issues. Primarily, they are concerned about the ramifications of high prices of inputs on the finished products. Take textiles, for example. The main carping has focused on the rising cost of production and how this has terribly affected the exports. There does not seem to be any clear-cut strategy to counter the cost of doing business. Sadly, the government is still occupied with other mundane matters and has put the latest textile package on the back burner till budget time. Please do note that whenever costs go up, the main industry of Pakistan, i.e. textiles, will invariably suffer, and suffer real big.

PAGE: Do you have any suggestion or message that you want to deliver in order to help contain inflation, which is the real impediment in our economic growth?

MA: It should be remembered that inflationary expectations, based on overall inflationary trends, are self-fulfilling with dismal consequences. The government should refrain from spin-doctoring that everything is hunky-dory. It is the duty of the government to be pro-active and act fast to attack any menace with pragmatic and doable strategies, and, of course, must ensure that public is kept aware of the real situation. Trust the people, not pseudo-consultants. The citizens know and experience the ground realities, not those who sit in the hallowed halls of the government buildings in Islamabad.