LINK OF INFLATION WITH EXCHANGE RATE
SHABBIR H. KAZMI
Sep 6 - 12, 2010
In the modern world countries thrive on their competitive as well as comparative advantages. No country is serious in producing every thing but prefers to source it from other countries offering competitive prices and best delivery terms. Pakistan cannot be an exception as it buys CKD/SKD kits of automobiles from Japan, crude oil from Middle Eastern countries, sugar from Brazil, chemicals from China, plant and machinery from global sources, etc. etc. Therefore, when prices of these commodities go up or down, these are also reflected in the domestic market. When Pak Rupee depreciates against global currencies, it adds to the cost. In other words, a combination of factors determines the prices of various commodities in the domestic market. When the trend is upward, it is referred as inflation.
In Pakistan, the factors also adding to inflation are interest rate, movement of food and POL prices in the global markets and rising cost of transportation and electricity and gas tariffs. Added to these are profiteering, hording, and black marketing. For example, hike in sugar price was not due to any shortage, but mismanagement and interruption and disruption in market mechanism. Increase in prices of wheat and other agriculture produce are due to hike in cost of inputs but mainly due to poor yield. Added to these are poor storage facilities resulting in wastages and presence of intermediary making the most at the cost of producers and consumers.
In 2008 prices of most of the commodities touched record peak levels in the global markets. This had the worst impact on Pakistan for two reasons: hike of price in the domestic market and added to this was worst depreciation of Pak Rupee, to the tune of about 28 per cent. Therefore, this could be said that during 2008 Pakistan suffered mainly from cost pushed inflation. This could have been avoided had the country not forced to import exceptionally high quantities of sugar, wheat and fertiliser. During this period, crude oil prices also touched historic high of around US$147/barrel. The hike in POL prices pushed prices of almost all the products to very high level.
Some of factors contributing to inflation in 2010 are the same but two outstand: 1) persistent hike in energy prices in the name of 'recovery of full cost' and 2) withdrawal of subsidy. The first factor is most obvious in case of electricity tariff. The proponent of this philosophy says that the successive governments have not been recovering the full cost, which resulted in inter-corporate debt. However, these novices fail to understand that the rise in debt is not because of the failure in recovering full cost but exceptionally high transmission and distribution losses, which are nothing but blatant power theft going on for decades with the connivance of staff of the electricity distribution companies.
The perception that government pays huge subsidy on various items is also incorrect. In fact, the cost differential is being born by other groups of consumers. For example, if government supplies electricity and gas to small consumers at lower rates, it charges higher tariff from commercial and industrial consumers. The myth about supplying gas (feedstock) to urea plants at subsidised rates is also incorrect because the billing is not on the basis of volume but calorific value of the gas, lower the calorific value lower the tariff. Fertiliser plants of Fauji Fertilizer Company and Engro Fertilizer get gas from Mari gas field which not only has lower BTU value but also contains higher percentage of carbon dioxide, which puts it below ëpipeline quality gas' and therefore its is sale of low quality gas at discounted price.
During 2009, Pakistan imported over 1.5 million tons urea at an average C&F cost of US$400 per ton. This not only ate huge foreign exchange reserves but also forced the government to pay huge subsidy because cost of locally produced urea was less than US$175 per ton. This imprudent decision added to budget deficit and resulted in extra borrowing by the government. Therefore, maintaining self-sufficiency in urea is necessary to avoid waste of foreign exchange and saving the government from payment of subsidy running into billions of Rupees.
If the government and the private sector is serious in containing inflation in the country a few harsh steps have to be taken. These include bringing down interest rate to single digit, rationalising electricity and gas tariffs by containing transmission and distribution losses of electric utilities and UFG of gas distribution companies. Production and productivity of the manufacturing sector has to be doubled. Yields of major crops also have to be doubled without bringing additional area under cultivation.
On top of this, Pakistan has to regain its comparative advantage of cotton. The country can get 20 million bales from the area currently under cotton cultivation. This will also help in enhancing local production of cottonseed oil. Pakistan can also bring down its edible oil import bill by bringing more area under canola and sunflower cultivation. Recently the government has fixed support price of canola and sunflower seed at Rs1800 per 40kg.
At present canola edible oil is being sold at Rs130/kg at retail level, whereas it is added in diesel to make biodiesel in various countries. Based on prevailing prices canola oil just cannot be added to diesel because of almost being double of its price.