MONETARY TIGHTENING AND INFLATION
SYED FAZL-E-HAIDER (firstname.lastname@example.org)
Feb 15 - 21, 2010
The Sensitive Price Index (SPI) inflation rose by 18.18 per cent in the week, which ended on February 4 compared to the corresponding week of the last fiscal year, according to the Federal Bureau of Statistics (FBS). The skyrocketing inflation is badly affecting lives of the people belonging to low-income groups. The inflation rate is feared to rise further after the government raised power tariffs in January by 14 percent and increased gas prices by 18 percent to help bridge the fiscal deficit.
State Bank of Pakistan kept its key policy interest rate unchanged at 12.5 percent for February and March, as the strife-torn country struggles to sustain growth and keep inflation in check because of higher power tariffs and poor cash inflow of the funds pledged last year at the Friends of democratic Pakistan (FoDP) summit in Tokyo. The country's central bank cut its discount rate by 50 basis points to 12.5 percent in November after keeping it unchanged at 13 percent in September.
"The inflation outlook remains vulnerable", said Salim Raza, the Governor State Bank of Pakistan on January 30 at a news conference in Karachi. Raza said inflationary pressure is there due to the increase in commodity prices in international market. He said average inflation for the current fiscal year was expected at 11 to 12 percent, down from 21 percent last year. Inflation was 10.52 percent year-on-year in December, after hitting its slowest pace in 22 months in October.
"The domestic inflationary cycle has already bottomed and will likely experience an uptrend over the next three months, as the hike in utility rates gets incorporated," reported Bloomberg Asad Farid, an economist at AKD Securities Ltd. in Karachi as saying. "Globally the monetary cycle is reversing which limits the State Bank's capacity to lower rates as it would spur rupee weakening."
With higher interest rate, Pakistan is on its way to becoming one of the most expensive countries of the world. The increased interest rate has made doing business increasingly expensive. The country witnessed closure of many industries last year and several more remained under the threat of closure following rising cost of doing business. The country is not even able to compete with the regional countries including India where the discount rate is just 5.7 percent.
While Inflation in India and Pakistan is almost the same but the policy rate in Pakistan is three times higher than India. High interest rates have marginalized the country's private sector. India's Reserve Bank kept problems of businessmen in mind and maintained low interest rates to keep the stimulus it provided last year to boost growth.
Pakistan was forced to turn to the IMF for a loan package of $7.6 billion that was agreed in November 2008, as the country was facing a balance of payments crisis and 75 percent of its forex reserves had shrunken. The IMF increased the loan to $11.3 billion in July last year and the central bank received the fourth tranche in December.
Critics say that the government has kept the policy interest rate unchanged under the IMF demand. A sustained improvement in the balance of payments would depend significantly on the timing and scale of projected foreign inflows, especially the flows pledged in Tokyo by the FoDP.
Some bankers however believe that lower interest rate will hurt inflows of dollars in the country and inflate the already inflated economy. They believe that the possible discouraging effects on foreign inflows need to be considered before reducing the interest rates.
Criticizing the tight monetary policy, the local industrialists and traders contend that unchanged discount rate would further increase the cost of production and destroy the industries, as it is already suffering from exorbitantly high business cost. As per agreement with the IMF, the government is committed to increase electricity rates by 30 per cent and it has already notified 18 per cent tariff increase. The recent 13.5 per cent increase in power tariff adversely affected the export-oriented industry and lifeline consumers in the country. Local business community believes that the increase in power tariff would have a disastrous effect on the cost of production of products and would render the producers uncompetitive both in the local and the international markets. This would also result in closure of industrial units and increase in the unemployment rate.
The hike in power tariffs would badly hit the industrial and business concerns, which are already in doldrums, due to highest-ever increase in the cost of manufacturing and doing business owing to the multiplicity of taxes and levies and excessive utility tariffs. The local manufacturers forecast more industrial closures and job losses over the next one year.
Despite pursuing a tight monetary policy and withdrawing subsidies on petroleum products, the government has so far failed to tame inflation, which is still at a higher side. The tight monetary policy has virtually failed to achieve its objective of combating inflation, which has pushed up the cost of living and made it the most important problem in Pakistan. The middle-class income group is slipping fast into the poor class while vulnerability of the lower classes has further been aggravated. Under the IMF programme, the country witnessed a significant economic slowdown, as macroeconomic stability took precedence over growth.
Analysts believe that cutting interest rates to single digit level will produce multiple benefits for the economy, as it will lower the cost of doing business, give a strong boost to business and industrial activities, provide easy credit and loaning facilities to trade and industry, promote better investment and exports and generate more tax revenue for the government. Some analysts argue that the central bank could have easily reduced the policy rate by 100-150 basis points by simultaneously increasing the Cash Reserve Ratio (CRR) and Statuary Liquidity Requirement (SLR) by one per cent.
The analysts believe that the Gross Domestic Product (GDP) growth has declined due to economic slowdown following the tight monetary policy, as irrationally high interest rates are holding back the growth. The decline in growth rate and decreasing currency value has led people to expect more inflation and massive increase in the joblessness.