ENERGY PRICES - THE RUTHLESS DRIVERS OF INFLATION

APPLICATION OF INTERNATIONAL STANDARDS: AN INTELLECTUAL MISTAKE

SHAMSUL GHANI (shams_ghani@hotmail.com)
Jan 07 - 13, 2008

Lots of academic efforts have been made to give at least a shape, if not a design, to our elusive economy. A number of research projects undertaken to test otherwise quite sound hypotheses have faltered in recognizing the real causes of our dismal performance in the economic field; notwithstanding economy's occasional show of brilliance every now and then. Structuralist school of thought emphasizes supply side factors (money supply, credit to private sector, exchange rate, wheat support prices etc) as determinants of inflation. One such study at IMF concludes that monetary factors are the main drivers of inflation in Pakistan. It further elaborates that wheat support prices influence inflation in the short term but not in the long term. These economists hold supply constraints the driver of inflation. To them wheat support price increase is the root cause of inflation in Pakistan. Various sophisticated tools like VECM (vector error correction model) and ADL (auto regressive distributed lag model) have been used to prove the hypothesis.

While such studies have a great archival value, nevertheless one has to take the conclusions with a lot of (not a pinch of) salt as they fail to take into consideration some realities peculiar to our economy. These realities are:

1. We are the only nation of South Asia Region not having done away with the feudalism. The production, supply and prices of all food items are controlled by the feudalists who are major and indispensable parts of our parliaments. Increase in wheat support price is made on the behest and for the benefit of this class.

2. The rampant corruption and smuggling are the major deflators of our economic growth.

3. We are still far away from developing a reliable economic data bank. Our so called CPI and SPI indices represent an erroneous composition based on arbitrary assigning of weight to various consumer items. Under this indices system ever increasing energy prices and their spiraling effect on over all economy are not correctly measured.

ENERGY PRICES DRIVEN INFLATION

Pakistan is basically an agro economy. The agricultural output is not evenly distributed among the four provinces requiring an efficiently operative distribution system. This entails substantial transportation cost which is transferred to the final consumer. Besides crop quality, the transportation cost which is the total sum of labor, fuel cost and depreciation plays a major role in setting the final price of agricultural output for the end user. On the industrial side too, the energy prices together with the labor and raw material costs determine the ex-factory price of the final product. The scarce supply position of energy often results in temporary breakdowns in the production process. The cost of these breakdowns also finds its way into the total cost of production and is thus passed on to the final consumer. From factory to the wholesaler, from wholesaler to the retailer and from retailer to the final consumer, the transportation cost of all three phases is added up to the cost of the final product to be borne by the final consumer. The dimension of energy prices driven inflation is huge and unlike wheat support prices induced inflation its impact envelopes the entire economy.

THE DEFECTIVE INDICES

The price level is generally measured by three indices namely CPI (consumer price index), SPI (sensitive price index) and WPI (wholesale price index). During the period July-November 2007, these indices showed the following percentage increases as compared to the same period of 2006:

CPI

7.85

SPI

10.87

WPI

9.88

This might appear to make an economic sense but if we go through the construction of these indices, the reliability factor is lost in the sea of skepticism. The following table shows the construction of CPI designed and relied upon by the Federal Bureau of Statistics:

Consumer Price Index (CPI)

(Base Year 2000-01 =100)

GROUP

GROUP WEIGHT

CPI NOV-2007

CPI NOV-2006

General

100

153.87

141.59

Food & beverages

40.34

167.22

148.70

Apparels, textile & footwear

6.10

131.84

121.32

House rent

23.43

151.73

140.14

Fuel and lighting

7.29

154.36

147.26

Household furniture & equipment

3.29

138.31

130.59

Transport & communication

7.32

146.85

151.60

Recreation & entertainment

0.83

106.21

105.87

Education

3.45

139.17

133.47

Cleaning & laundry etc.

5.88

134.36

123.53

Medicare

2.07

129.81

120.26

The weights assigned to utilities, education and medi-care are not realistic in view of ever increasing utility prices and highly expensive education and medi-care. The reliability of economic data provided is being questioned since long. The private sector economists are insisting on double digit inflation for the last so many years. Their assertions carry weight especially when we have seen the food inflation going as high as 13.4 per cent during the last quarter of 2007.

WHAT IS IN STORE?

The oil prices have touched the $100 mark. The prices of gas have been increased for commercial and a part of industrial sector. A hefty increase in oil prices is on the card. Gas reserves are depleting fast. Around $100 billion are due for payment to oil marketing companies on account of difference in international and domestic oil prices. The government is contemplating to pay off this liability through bank borrowing. Who is going to bear the interest cost? We are definitely on the anvil of another price hike of great magnitude. In developed countries and even in the developing economy of India, the energy and food prices are kept at minimum to provide relief to common man. India's oil marketing companies are running in red. On the contrary our government is trying to oblige our oil marketing companies who have already gulped down huge inventory profits.