State Bank seems to be complacent with the deceleration in the 'core' non-food/non-oil inflation.

Feb 05 - 11, 2007

Inflation is the measurement of the increase in prices of the goods over a period of time. It is generally attributed to the Consumer Price Index (CPI) covering 374 items. The Federal Bureau of Statistics calculates the inflation on monthly basis. It is also termed as 'headline inflation'. When for the purpose of calculation 'food and oil' items are excluded, it is named 'core' or 'non-food/non-oil' inflation.

It is the responsibility of the State bank of Pakistan (SBP) to keep the inflation within the reasonable limits. The tools available to the SBP for the purpose are: (i) tightening the monetary policy in order to keep the credit/monetary (M 2) and reserve money expansion in control having regard to the needs of the economy's projected growth by, inter-alia, raising the interest rates, (ii) sucking excess liquidity from the market by conducting Open Market Operations (OMOs) whenever considered necessary, (iii) increasing/decreasing CRR (cash reserve requirement)/ SLR (statutory liquidity requirement) viz-a-viz the deposits of the banking sector and (iv) initiation of selective credit control measures including banning the flow of credit to specific sector(s) or putting loans against certain commodities on 'margin' to guard against misuse of the bank loans. SBP used almost all the above measures during the last 18-21 months.

Let us now examine the impact of these measures keeping in view the contents of the two documents issued by the SBP on 18th January, 2007; one is the first quarterly report (QR1) for the fiscal 2006-07 (FY-07) and the second is the Monetary Policy Statement for January-June 2007 (MPS).

At the time of preparation of the budget in June 2006, the target for CPI for FY-07 was fixed at 6.5. SBP has at the mid fiscal expressed the opinion that it will not be possible to remain within the target and by the close of the fiscal, the CPI may rise to 6.6-7.2 per cent.

As is put by QR1, the year-over-year (YOY) increase in the CPI in November 2006 was 8.1 per cent. This high jump in the CPI is stated to owe its origin to the sharp rise in the prices of food items which has resulted in YOY increase in the food inflation to 10.6 per cent in November 2006..

According to the report, there are five major components of this increase: (i) Food 53.1 per cent, (ii) House Rent 19.2 per cent, (iii) Transport and Communication 3.3 per cent, (iii) Fuel and Lightening 9 per cent and (v) others 15.4 per cent. The figures in respect of items (iv) and (v) have not been specified in the QR1 but the same had to be deduced from 'Figure' 3.4. Let us now translate these components in 8.1 per cent CPI in Table I appended below:






53.1 %

8.1x53.1/100= 4.30

House rent

19.2 %

8.1x19.2/100= 1.56

Transport communication

3.3 %

8.1x 3.3/100= 0.27


9.0 %

8.1x9.0/100= 0.73


15.4 %

8.1x15.4/100= 1.24



It will be seen that the increase in the prices of food items is responsible for over 53 per cent jump in the CPI. Transport and the fuel play an important role in pushing up the prices of almost all the goods. The role of these two components in the overall inflation of 8.1 per cent works out to 1 per cent i.e. it contributes 12.34 per cent to the CPI which is quite substantial. As the data about lightening has not been separately provided, one can guess to put the fuel/transportation's contribution at least at 10 per cent. Even in that scenario, the role of fuel/transportation in the inflation is quite substantial.

In the MPS, it has been asserted that in case the impact of rise in the prices of onions and tomatoes is excluded, the food inflation will come down to single digit as the contribution of these two items in food inflation is 36.9 per cent. This, prima-facie, is a highly exaggerated estimation.

Between April and November, 2006 the prices of food items rose very sharply. QR1 presents analysis about 112 items: the prices of only 11 items fell while the prices of 101 items rose. The inflation range is given in Table II appended below:




0-5 per cent


5-10 per cent


10-15 per cent


15-20 per cent


20 per cent and above




It can be seen from the above table that the rise in the prices of 51 items was over 10 per cent during 7 months period [April-November, 2006].

SBP has been time and again emphasizing that the monetary policy cannot alone bring down the prices of food items and that administrative measures on the part of the government to manage the supply side are additionally needed. But when measures under monetary policy are required, it fails. The recent instance is that of loans obtained by the sugar millers for hoarding the sugar stocks. SBP was merely watching the hoarding of sugar stock as its own reports (SBP report for the 3rd quarter of FY-06) testified that during the first nine months of FY-05, the sugar millers had sold out 99.7 per cent of their stocks but during the same period of FY-06, they sold only 43.1 per cent of their stocks. The situation warranted prompt use of selective credit control measures but SBP very belatedly directed the banks to get the old loans cleared by a certain date and that future loans would be subject to 50 per cent margin. After a few days only, the date for liquidation of the old advances was extended and soon thereafter the whole scheme was withdrawn.

SBP seems to be complacent with the deceleration in the 'core non-food/non-oil inflation. In a country where about 40 per cent of the population lives in abject poverty, the deceleration in the 'core' inflation can provide no comfort as a very substantial portion of the income of these poor people is spent on food items.

Government has recently reduced the prices of petrol and diesel by Rs 4 and Re 1 per litre, respectively. SBP has reposed the hope that this reduction in the oil prices will have the dampening impact on the inflation [MPS]. The beneficiaries of the reduction in the petrol prices will be the individuals driving four/two wheelers and hence it cannot have any impact on the inflationary trends. Diesel is used for agricultural and industrial purposes as well as by the transporters plying buses for the poor people and trucks for transporting goods. The transporters have already refused to bring down the passenger fares/ goods transportation cost. As the reduction will not provide any comfort to the transporters/industrialists/agriculturists, the prices of the manufactured/ agricultural goods will also not come down. SBP's expectations in this context hardly have any rationale.

One of the factors causing upsurge in the inflation is increase in the monetary expansion (M2)/ reserve money. SBP has expressed concern over the rapid expansion in the reserve money causing inflationary pressures; the causative factors being provision of subsidized short-term finance for the exports/ conversion of long-term loans granted to the export-oriented industries for machinery procurement into subsidized ones and grant of new loans for the machinery purchases at the subsidized rates. The footnote of the MPS says these loans contributed about 54 per cent in the reserve money growth during July-December,2006 as the outstanding export finance loans funded by the SBP amounted to Rs 131.5 billion, while SBP's resources blocked in long term loans aggregate Rs 43.1 billion as on 31st December, 2006.

During the last 3-4 years, SBP has not only been meeting the entire credit requirements of the government but has also been aiding the government to reduce commercial banks' debts by borrowing funds from it even though it accepts that the government borrowing from the central bank is highly inflationary. Necessary details in this regard are appended in the following table:







State Bank of Pakistan





Commercial Banks


(-) 83.80

(-) 64.1

(-) 51.00

Source: SBP annual reports/ SBP Monetary Policy Statement for January-June,2007.

The fundamental question is whether is it the job of the SBP to formulate/ enforce monetary policy with a view to curtailing (or at least containing) the inflation or is it also its job to administer trade/commerce/fiscal policies? The provision of the subsidized credit to a specific sector of the economy is the government's job and it should do it through budgetary appropriation. (There are reports that the concessional finance is being misused by the borrowers). SBP should not become a party to adopt the measures conducive to cause inflation. Likewise, SBP's meeting the government's entire funding needs (including retirement of commercial banks' debts) can also not be justified. These measures run counter to the SBP's responsibility of decelerating inflation and seems to have already nullified or would be nullifying in future the impact of monetary tightening and other anti-inflationary measures put in place by the SBP during the last 18-21 months.

An interesting point is that Pakistan is the only country where GDP growth in FY-06 (6.6 per cent) is much lower than the inflation rate of 7.9 per cent that year. Whenever our economic managers consider expedient, they make comparison with India. During 2006, GDP growth in India was 9.2 per cent while inflation was 6.7 per cent. Other countries of the region where GDP growth (2006) has been much higher than the inflation are: Philippines, Thailand, Malaysia, South Korea, China and Taiwan. The case of China is very exceptional one where GDP growth exceeds 10.2 per cent but inflation has been contained at 2 per cent.

What one can conclude from the above discussions is that if the SBP continues with the existing policies while paying lip-service to the cause by reprimanding the government not to borrow from it - such borrowing being inflationary and continuing with providing subsidized funding to the industrial sector - it is very unlikely that inflation will either decelerate or be contained.