ECONOMY IN STAGFLATION
July 4 - 10, 2011
Pakistan's economy is virtually in stagflation, as the country witnessed low economic growth and high inflation during the fiscal year 2010-11 ended on June 30. The country failed to meet its economic growth target as the economy grew by 2.4 percent in the fiscal year 2010-11, against the target of 4.5 percent. The inflation rate during the fiscal year 2010-11 remained over 14 percent, while electricity went costlier by 24 percent.
The inflation has been on the rise due to government borrowing from the banking system and increased currency in circulation. The monetary expansion rose sharply by Rs677 billion in less than eleven months of last fiscal year, against Rs222 billion in the same period of last year. The State Bank of Pakistan maintained a tight monetary policy throughout the year. Analysts believe that the massive monetary expansion would not allow the economy to see single digit inflation during next fiscal year, while it would also force the central bank to keep the interest rate unchanged.
The double-digit inflation has become a serious problem for the south Asian country where up to 40 per cent of its 170 million population live below poverty line.
Astonishingly, the country is maintaining one of the world's highest benchmark interest rates, in an economy hurt by inflation, terrorism and falling foreign investment. Though the central bank's tight monetary policy could not tame the soaring inflation, yet it did stagnate the economic growth. The central bank cannot allow monetary easing because of rising inflation amidst worries about price pressures and expansion in fiscal deficit. Soaring inflation has not only raised the credit price but also weakened the purchasing power of the people.
The economic managers in Islamabad need to control the inflation and boost growth to prevent the country from going into a prolonged spell of stagflation.
During the last fiscal year, the inflation-fueling government's borrowing from the central bank and its heavy reliance on printing of notes has left the central bank with no option but to further raise its key policy interest rate. The printing of notes is bound to create very high rate of inflation forcing the central bank to further tighten its monetary policy.
The easy recourse to increased borrowings from the central bank, the experts say, leaves little incentive to the government to put its badly needed fiscal situation in order. Poverty ratio in the country is rapidly rising due to economic slowdown, high inflation and reduction in subsidies, and the poverty ratio during the fiscal year 2010 surged by some four percent to 40 percent, as it stood at 36.1 percent in 2009.
In the last fiscal year, the manufacturing sector has seen only a three per cent growth. The tight monetary policy has not allowed the private sector to play its key part as engine of growth. High borrowing costs discouraged the demand for private sector credit, which in turn decreased private investment adversely affecting the prospects of economic growth. High interest rate has been the key reason behind the negative growth in the industrial production and closure of many industrial units.
Critics say that the central bank's tight monetary policy is silent about the issues of effect of the policy rate to inflation. Monetary policy actions transmit their effects on macroeconomic variables with a considerable lag and with a high degree of volatility and uncertainty. The increase in interest rate would increase interest payments on government debt, which will cause an even higher fiscal deficit, despite higher profits of the central bank.
Other reasons for low GDP growth in the last fiscal year have been the devastating floods and militancy. The war on terror has cost the Pakistan economy $17.8 billion in the current fiscal year, while catastrophic flooding in August cost the economy $10 billion.
"Western countries, including the United States, continue to impose a travel ban for their citizen (investor, importers etc.) to visit Pakistan," said the document, reviewing the economy from July 2010 to April 2011. "This has affected Pakistan's exports, prevented the inflows of foreign investment, affected the pace of privatization program, slowed the overall economic activity, reduced import demand, reduced tax collection, expenditure overrun on additional security spending."
Analysts believe that the government income in the form of taxes has significantly reduced due to worst floods and the government is forced to borrow from the financial market to meet its everyday business. Some analysts however do not see the floods as the only reason for rising inflation as they consider continuing fiscal imbalance and consistent power tariff increase as other important reasons triggering inflation in the last fiscal year.
The government has been unable to inject any semblance of fairness in the tax system, which accounts for tax to gross domestic product (GDP) ratio of 10 percent, one of the lowest in the world. Secondly, high inflation is rooted in the country's monetary policy that continues to be held hostage to the acute imbalance in the country's fiscal position. Finally, the government's periodic upgrading of electricity rates, as well as of other utilities, is further fuelling the inflationary spiral.
Pakistan is among the Asian countries, which are experiencing unexpected price pressures to varying degrees driven by higher prices of food items, which constitute the single most component of the consumption basket from 30 to 40 per cent over much of the region, according to a report of UN regional commission for Asia and the Pacific.
The Sensitive Price Indicator (SPI) inflation for the week ended on June 23, for the lowest income group up to Rs3,000, has registered increase of 0.57 per cent over the previous week, according to Federal Bureau of Statistics (FBS). As compared to the corresponding week of last year, the SPI for combined group in the week under review witnessed increase of 16.24 per cent.
The experts warn that the government's inability to control its increased borrowing for current expenditure may push Pakistan into a prolonged spell of stagflation. In the new fiscal year 2011-12, the economy is likely to witness low economic growth and high double-digit inflation - the classical characteristics of an economy in stagflation.