INFLATION IMPACT SPREADING OUT

SHAMSUL GHANI
(feedback@pgeconomist.com)
Apr 11 - 17, 2011

Referring to the global financial crisis and its aftermath, the IMF head, Strauss Kahn has recently underlined 'inequality' as one of the 'silent' causes of the financial crisis. Comparing the recent financial crisis with the Great Depression, he pointed out that the 1929-30 crisis preceded by an increase in the income of the rich and a growing financial sector. Lamenting the low growth in rich countries, he commended the high-power growth taking place in emerging economies of Asia and Latin America. According to him, the low-income countries proved remarkably resilient, but are now hit by high food and fuel prices.

ADB stance on Pakistan's economic conditions can be termed both realistic and callous. Serious revenue slippages, fiscal deficit crossing the imagined line of 5.5 percent, continuous bleeding of public sector organizations, a low estimated GDP growth all are realities. Electricity shortage eating away almost two percentage points of GDP growth is also an unfortunate fact. But, criticizing the government for increase in the salaries of government employees is certainly callous. International agencies preaching global commodity and energy price parity should demonstrate a humane approach by recommending or at least appreciating any measures aimed at reducing income inequality. ADB has also expressed its discontent over government's go-slow approach toward eliminating all energy-based subsidies. According to it, the 37 percent increase in electricity tariff during FY-10 was not enough and further required incremental two percent monthly step-ups. International financial institutions are trained in the game of numbers. They live numbers, eat numbers, and sleep with numbers. The recent financial crisis of almost immeasurable magnitude has also failed to awaken them to the reality - the reality that the time to play with numbers is over as the 'number empire' has been comprehensively demolished at The Wall Street. It is time to think in human terms. Work for the betterment of humanity lest you too are demolished as an organization.

Inflation in Pakistan is fueled by a number of factors toxic exports leading to high food prices for the domestic consumers, corruption-ridden governance, high government borrowings to meet fiscal deficit, choked foreign investment lines, depreciated domestic currency, stagflation created by monetary policy failure, and rising oil and energy prices. Revenue slippages caused by corrupt revenue generation and collecting systems are countered by devising easy and forced revenue augmentation methods - the simplest being the increase in POL products prices.

The nation has suffered from endless bouts of such increases during the last three years. Frequent energy price hikes have pushed petrol prices from Rs63 a liter to Rs84 a liter (a 33 percent increase); high speed diesel prices from Rs44 a liter to Rs93 a liter (a 111 percent increase); CNG prices from Rs37 a kg to Rs55 a kg (a 49 percent increase); and LPG prices from Rs53 a kg to Rs95 a kg (a 79 percent increase).

The latest 10-13 percent increase in the prices of petroleum products coupled with the imposition of new taxes/levies is going to unleash a fresh wave of increase in commodity prices and transport fares. The CPI, which has already gone up from 12.91 percent in February to 13.16 percent in March, is yet to show the result of this latest increase in POL prices. According to the Asian Development Bank estimate, the inflation in Pakistan may rise to 16 percent by June this year mainly because of high global food and commodity prices. ADB has however, expressed hope that the inflation might come down to 13 percent next year. IMF's forecast about Pakistan's annual inflation is less harsh - 13.5 percent. ADB or IMF, or an average of the two forecasts, the vulnerable groups of Pakistan are bound to suffer, in any case. A more disturbing increase is that in the wholesale index which has gone up by 25.4 percent in March. When this increase travels down to the retail level, commodity prices will further increase and in turn push the CPI further up.

The recent flare-up of oil and gold prices has its roots in the unrest brewing in Middle East and North African regions. Like wolves, inflationary stimulants hunt in pairs. Rising oil and gold prices are two of the most powerful inflationary stimulants. Being mindful of the recessionary trends in the global economy, the hedge and sovereign fund managers appear to have their focus set on precious metals and oil. A few months back, oil appeared to be range bound - $75 to $85 a barrel - and global economic planners looked content with the situation. The ongoing Arab world political crisis - difficult to say at this stage if it is part of a US/West game plan - has come as a boon to the speculators. The spread between New York light sweet crude (or WTI crude) and London Brent North sea crude oil prices used to be around a dollar. It is now as high as $14, with New York crude being quoted at $108 a barrel and London Brent crude at $122 a barrel. This situation has developed because of the supply constraints engendered by the Arab crisis.

The cost-push inflation caused by the oil price hikes ensues from our reliance on oil as major source of energy. We produce about 60 per cent of our energy from oil/gas-based operations. Beside, increasing domestic oil output, we will have to gradually do away with the use of oil for power generation. Use of oil by the transport sector should also be minimized by converting to CNG-based transport system. Modern mass transit projects also need to be designed and completed on an emergency basis. This will not only minimize the use of private transport but will also improve the fast deteriorating traffic situation throughout the country. Unfortunately, our depleting gas resources also pose a future threat. New investment in the field of oil and gas exploration will have to be attracted by offering incentives to the local and foreign investors. Another option is to switch from oil-based to coal-based energy. Coal is globally considered as one of the most important source of energy. Pakistan is said to have about 185 billion tons of coal deposits located in Sindh, mainly at Thar. It is unfortunate that the exploitation of this important natural resource has been delayed. Hydropower is a cheap and clean alternative source of energy. Pakistan produces 34 per cent of its energy from water. The country's available water resources can generate approximately 50,000 MW - more than double the country's current requirement. Following the example of China, we need to develop a network of smaller dams and utilize our abundant coal resources in earnest. These are all long-term energy security programs. As a short-term strategy, we need to make effective use of energy subsidy programs. We also need to convince international lenders that these programs can restrict the inflation to a manageable limit.

Subsidy is a tricky issue. Most of the developed nations use it to save their farmers from competition. International lending agencies, more often than not, take a negative view of this economic policy tool, particularly when it is used by developing economies. The World Bank Group's energy sector strategy paper (July 2010) spells out pros and cons of energy sector subsidies. The following guideline - contained in the said paper - focusing on effective use of subsidy may be followed by struggling economies like Pakistan:

"Efforts should be made to provide targeted assistance to vulnerable groups, such as lower-income households who will be adversely affected by subsidy changes. Compensation needs to be visible and sufficiently material to offset a good part of the adverse effect in the early years of the change. Consideration should be given to alternative policy tools to protect the poor, such as cash and non-cash transfers, and, for electricity, district heating, or natural gas, lifeline rates or volume differentiated tariffs. Subsidies for connection charges can also be targeted to the poor, but may need to be limited in countries where the connection rate is low."