INFLATION: A REALITY OF PAKISTAN'S ECONOMY
Among its peers in S. Asia, Pakistan would be one of the few economies where inflation is higher than the real GDP growth
Senior Analyst — Head of Research
AKD Investment Management Ltd.
Jan 29 - Feb 04, 2007
In the recent past Pakistan has experienced rapid growth as a result of increased global significance of the country due to major shift in geo-political trends that brought about changes in the socio-economic environment of the nation. Pakistan largely remains an agriculture-based economy but pace of industrial development has picked up significantly in the recent years as a result of political restructuring and favorable international factors.
Monetary policy objectives for this new economy pose a renewed challenge to the regulators as appropriate money-market measures would ensure sustainability in the economic growth of the country. The State Bank of Pakistan is at the forefront of this battle to achieve economic growth targets without overheating the economy and inflation control remains the dictating factor in its governing policy.
Pakistan's inflation growth is estimated to remain above the SBP target of 6.5% for FY 06-07. This would not be a new phenomenon for the regulators; SBP has missed its target estimates before and for the same reason: lacking an industrial base, Pakistan is largely dependent on imports of fuel, raw materials, manufacturing machinery & industrial equipment, high-tech consumer goods and vehicles, therefore, it is very hard to isolate international price pressures from influencing the domestic economy.
Domestic factors are also important since a large proportion of the country's GDP comes form the agricultural sector where yields are in turn dependent upon weather and availability of water, which make the production uneven from year to year. In bad crop years Pakistan has to import large quantities of foodstuff to meet the requirements of its ever-growing population, which not only skew the balance of payments but also increases inflation in the economy.
In spite of bumper crop production that Pakistan achieved this year, the hike in the oil prices kept up basic resource cost that is reflected in the current year's numbers. Among its peers in S. Asia, Pakistan would be one of the few economies where inflation is higher than the real GDP growth; overall inflation stands at 8.4% for the last 6 months but it is likely to decrease slightly going forward due to the lower international oil prices.
Short-term monetary measures have remained the tool of choice for the SBP to control money quantity and the central bank has remained very active in damping out liquidity form the banking system through regular sale of T-Bills. The interest rates in Pakistan are also very high in comparison to the world average; Pakistan's sovereign debt rating was recently upgraded by Moody's Investor Services to B1 from B2; consequently that makes Pakistan's outstanding sovereign debt one of the cheapest with highest yields in its asset class. These developments have been somewhat successful in stabilizing the value of Pakistani Rupee relative to the US Dollar but the Rupee's value depreciation is much higher against other foreign currencies; most notably against the Euro.
There is an eminent need to revitalize the long-term borrowing through the PIBs and FIBs and reduce reliance on T-Bills so that a long-term debt management policy could be evolved that would reduce the credit risk that is currently faced by the government.
The SBP has started to re-issue longer tenure PIBs but at the moment appetite for longer tenure debt is limited to a handful of institutions from insurance industry and a more liquid secondary market is needed to make long-term debt attractive for institutions in other sectors. Instead, the government has resorted to re-allow institutional investment into the National Saving Schemes to prevent the upcoming maturities in Defence Saving Certificates from flooding the money market and cause further decline in the value of Rupee. National Saving Schemes are unfunded form of high yield long-term debt that have the tendency to put unsustainable debt burden on the economy in the long run.
Pakistan requires a permanent long-term solution for debt management in order to maintain Rupee value parity. High debt accumulation and absence of a comprehensive debt management framework will put severe pressure on the Rupee value and cause higher inflation in the future.
It is repeatedly argued by the analysts that food inflation should not be included when analyzing the industrial growth and development numbers which is largely true since industrial output has little to do with this area but the reality is that food and housing prices are facts of life that every Pakistani has to deal with on a daily basis and a developing nation with rampant poverty cannot afford to ignore the rise in basic standard of living costs while boasting about its industrial growth.
It is a fact that the central bank policies have little effect on food and housing prices since their fundamentals are not directly tied to the availability of borrowing capital but at the same time food and housing prices are of crucial importance in determining the standard of living in the country for the average household unit and any increase in these prices has an effect similar to that of a regressive tax which is increasingly biased towards lower income residents.
In order to properly address this problem of food and housing inflation a broader policy prospective is needed otherwise inflation will continue to burn a hole in the pockets of hard working citizens in the coming years. It is obvious that two separate approaches would be needed to address the food and housing price issues in appropriate manner.
Housing and real estate industry is beset by speculation and lack of documentation that makes it very troublesome to ascertain and compare the property values in different areas of Pakistan with accuracy. Speculation artificially raises the prices of real estate without contributing towards capital formation and is therefore extremely detrimental to the economy. The lack of proper documentation and records is also a big hindrance in the development of a professionally managed and broad based real-estate investment trust (REIT) industry that could provide both ease of property acquisition and financing for the tenants and a secure asset class for the investors. REITs are also an excellent source of price discovery and comparison for real estate and serve as a counter speculation tool. Furthermore, Islamic Real estate Investment Trusts (I-REITs) are being extensively used in other Islamic counties like Indonesia and Malaysia as Shariah compliant investment vehicles.
Any significant development in the regard would require that the government first make the real estate sector documented adequately so the rights of ownership are protected and take steps to curtail the speculative behavior of real estate traders. Proper regulation of the housing and real estate would ultimately help to control housing inflation in the country.
Food price stability is an even broader based objective but countries have found ways to smoothen the price volatility caused due to demand and supply gaps in food and agricultural products. One way is to introduce agricultural futures and options that would help control price deviating too much from long-term as wider discrepancies in prices are arbitraged away by market participants. The practice is commonplace in the US where agricultural futures were introduced a long time back in the Chicago Board of Trade that retain their significance to date and have paved the way for other countries across the world to buy and sell through this system.
Another more reliable way could be that government can provide agricultural produce buffers across Pakistan in the form of grain elevators and storage houses and actively participate in buying storable agricultural produce including grains, pulses and perhaps even sugarcane in good crop years and releasing the stocks in bad crop years to provide price stability year after year. This system is more appropriate for Pakistan because it is operated by the government which makes it a non-profit oriented national welfare project and it guards against the eminent weakness of the derivates system that leaves markets vulnerable against attempts to corner the market or to speculate by large investors or hedge funds, these vulnerabilities are even more likely to be exploited in smaller economies where there is unequal distribution of wealth as in the case of Pakistan.
It remains for the regulators to decide upon the set of measures that would be best suited to Pakistan's economy but it is vital that some course of action is chosen and put into action on priority basis to establish a grip on the fundamental issues in view of the greater national interest of achieving price stability across the economy and to make macro-economic policies more reliable.
AVERAGE PRICES OF THE FOLLOWING 17 ITEMS REGISTERED INCREASE.
PRICES IN RS ON
% CHANGE OVER
MOONG PULSE WASHED
VEG. GHEE (TIN)
COOKING OIL (TIN)
L.P.G.( 11 KG CYLENDER.)
GRAM PULSE WASHED
RICE BASMATI BROKEN
WHEAT FLOUR AV. QLT.
MASOOR PULSE WASHED
SOURCES:STATE BANK OF PAKISTAN
AVERAGE PRICES OF THE FOLLOWING 11 ITEMS REGISTERED DECREASES.
PRICES IN RS. ON
% CHANGE OVER
EGG HEN (FARM)
MASH PULSE WASHED
SOURCES:STATE BANK OF PAKISTAN