UNYIELDING MONETARY POLICY
THERE IS A NEED TO CONTROL FACTORS RESPONSIBLE FOR FUELING INFLATION.
SHABBIR H. KAZMI
Dec 27, 2010 - Jan 2, 2011
Policy planners in Pakistan face 'egg or chicken first' when it comes to bringing down discount rate. The policy of keeping interest rate high to control inflation has failed in getting the desirable results but the policy is pursued. The disappointing point is that a lot of energy and time is wasted in proving that keeping interest rate has helped in containing inflation. One does not know whether if at all the policy planners will understand that Pakistan suffers from cost pushed inflation and keeping discount rate high only added to the inflation.
On of the worst fallout of following higher interest policy is deferment of investment decisions and high cost of doing business. Many of Pakistan's industries are highly leveraged and persistent hike in interest has proved detrimental for the producers as well as the consumers. With each hike in interest rate probability of becoming delinquent increases because financial cost eats the entire margin. Either the companies post nominal profit or post loss. In an attempt to maintain profit margins price hike is often more than the increase in financial cost.
Persistent hike in interest rate, also leading to hike in cut off yields on treasury bills, encourages the banks to invest bulk of deposits in government papers. In the latest treasury bills auction the central bank was able to mop up over Rs100 billion rupees with nominal increase of yield mainly because bids received amounted almost double the auction target. It may not be wrong to say that the banking sector is suffering from excessive liquidity.
According to some analysts, the first preference of commercial banks is treasury bills and second stock market. Investing in government papers is not only risk free but also yields are also very attractive. Almost all the banks have established asset management companies. Lately, money market funds have attracted a lot of investment. While the funds investing in fixed income instruments, mostly term finance certificates, suffer from redemption pressure tons of money is being invested in money market funds.
Many experts are of the opinion that rising trend of commodity prices is the key reason of high inflation in the country. Crude oil prices are inching towards US$100 a barrel. As a result, POL prices in the country have to be adjusted upwards. Hike in prices of high speed diesel and furnace oil have impact on the prices of almost every thing. However, the worst is hike in electricity tariff. Over the last 30 months, electricity tariff has been more than doubled, partly due to hike in crude oil price but mostly in the name of recovery of full cost. However, the worst fallout has been proliferation of electricity theft, T&D losses hovering above 40 per cent. Therefore, the worst hit has been those who pay their electricity bills regularly and full.
In the recent past, prices of many commodities went up due to devastating floods, and not came down with the receding waters, mainly because of destruction of standing crops. In fact, government has to allow import of vegetables to keep prices at modest level. Ironically, government has allowed export of onion, which has pushed up its retail price beyond Rs60 per kg. Some of the experts say that limited supply of vegetables and fruits is not the reason for higher prices but profiteering motives are the main cause. The government has failed in monitoring retail prices.
Sugar retail price after touching a record high of Rs120 per kg in certain parts of the country has come down but is still hovering around Rs80 per kg. Hike in sugar price can be attributed to acute shortfall in sugarcane output allowing the growers to sell sugarcane much above the support price fixed by the government. The shortfall could be gauged from average capacity utilisation. As against an installed capacity to produce nine million tons refined sugar per annum, sugar production mostly remains below 3.5 million tons. Ill-timed import also forced the Trading Corporation of Pakistan to import sugar at very high price and government paying billions of rupees subsidy.
Pakistan has the potential to become exporter of cotton, wheat, and sugar and also curtail import of edible oil through introduction of right policies. In fact not much is required except supplying certified and high yielding seeds, telling farmers to apply appropriate dosage of different types of fertilisers and ensuring adequate supply of irrigation water. Proper crop management could help in doubling the yield of major crops.
Last but not the least government has to ensure uninterrupted supply of electricity and gas at affordable cost. Not only electricity generation has to be increased but also T&D losses have to be brought down drastically. Closure of mills due to outages of electricity and gas not only reduces production but also frustrates efforts to achieve economies of scale and produce exportable surplus.
The government must also remove the impediments affecting production of agriculture and manufacturing sectors to improve production and productivity. It is encouraging that foreign investors are showing interest in investing in Pakistan but they have to be offered right incentives. Let it be very clear, that Pakistan has to offer better incentives as compared to those offered by India.