Aug 8 - 14, 2011

State Bank of Pakistan took an unexpected turn in the monetary policy announced recently of cutting discount rate by 50 basis points to 13.5 per cent after cumulatively pushing its up 150 basis points in the first half of last fiscal year (2010-11).

In view of the double-digit inflation rate (13.9 per cent annual through June) that has been an excuse for the central bank for many months to keep benchmark interest rate at high level, that was really a surprising move albeit not satisfactory.

Maybe, the bank was anticipating decline in inflation as it commented in the monetary policy statement or it has started to realise the nature of price inflation-in Pakistan-that experts said is clearly an outgrowth of supply shocks.

Interplay of fiscal and structural measures should be called in to rein in commodity price-triggered inflation, said ADB in its semi-annual Asia Economic Monitor report. It also however recommended monetary policy responses to volatile food and energy prices.

While the first advice of the development bank must be taken seriously by the likes of Pakistan's economy, logically second recommendation should be analyzed under the perspective of economic growth.

Asian Development Bank (ADB) expected upsurge in inflation in the region due to high commodity prices. Quake-Tsunami-hit Japan's economy would send a shiver upward in the costs of production internationally.

Until February this year, food prices jumped year-on-year to 30 per cent and if this trend continues throughout the year gross domestic product (GDP) growth for some food importing countries would slide 0.6 percentage points, it said.

High world oil prices would also cut down GDP by another 1.5 percentage points. From June 2010 to February 2011, world food prices rose 40.4 per cent. Individually, sugar prices shot 86 per cent, cereals 68 per cent, edible oils 66 per cent, dairy products 13 per cent, and meat 11 per cent.

The report, notably, focussed on emerging East Asia economies that are undergoing rise in inflation, but used to cultivate growth rates as high as eight per cent. Its growth forecast for these economies is an average 7.9 per cent in 2011 and 7.7 per cent in 2012. Emerging Asia comprises of Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, Vietnam, China, Hong Kong, South Korea and Taiwan.

A number of factors including exchange rate, trade policy, and other policy measures determine the impact of rise in global prices over domestic economies that import food. Fluctuation in world commodity prices does not always result in proportional up and down in domestic prices.

Global food price rise leads to surge in general inflation in many Asian economies that carry large food weights in consumer price index: Bangladesh (59 per cent), India (46 per cent), Sri Lanka (46 per cent) and Pakistan (40 per cent).

Counterbalancing the slowdown in European and US economies, Asian economies run financial stimulus to enable domestic demands to withstand the slowdowns. ADB warned them that inflationary pressures would aggravate in case of oblivious crisis-related stimulus.

Why the bank expected room for tight monetary policies was because policymakers in the emerging economies had yet to wield monetary tools to control inflation and by raising discount rates, they would not actually damage their domestic demands. "Policymakers should be careful not to overreact to the slowdown in advanced economies, as regional growth remains resilient and inflation a continuing problem," it said.

Come Pakistan, the scenario gets changed completely. The country has one of the lowest growth rates in the region but it is exposed to the regional spectre of double-digit inflation.

The central bank is reluctant to soften policy rate as it may trigger inflation. High interest rate stymies the economic activities rather suppressing the domestic demands.

Private sector is deprived of liquidity that it needs to rev up stalled economic growth. The liquidity is however finding its way to plugging fiscal gaps and ends up in lending to the government that indeed is inflationary.

The government is not discouraged to take loans from the banks despite prohibitively high cost of capital. Private sector cannot afford high interest bearing loans since such costly loans increase their cost of productions, and render them uncompetitive internationally or to the imported products.

Developing Asia that includes Pakistan is likely to reel under spiking inflation and slower economic expansion if global food prices persist on the upward course, said the report. "Net food importing countries would be the hardest hit in this scenario."

Experts said if food price inflation is supply-driven, increasing interest rate may not be effective in calling the shots.

Reduction of taxes, export restrictions, and food subsidies and aids can be the ideal tools for curbing food price inflation in Pakistan. Efficient price control mechanism and rectification of supply chain management can also lead to reduction in price inflation that is grinding down consumer's buying power and causing upsurge in the poverty incidence.

Monetary policy-driven decline in inflation leads to choking off investment rate that for an economy like Pakistan is analogous to requiem.

Almost each sector of the economy is in need of investments. Pakistan's investment to GDP ratio dropped 10 per cent to 13.4 per cent in 2010-11 from 22.5 per cent in 2006-07. For an average growth rate of 4.9 per cent, this ratio should rebound to 17 per cent, according to the Planning Commission.

Regional cooperation can also play an important role in bringing stability in the prices of food and energy and investments. "There is a greater appetite for regional cooperation especially on capital flows and dealing with inflation," Iwan Azis, an ADB official said in an interview to the Wall Street Journal.

Inflation in Pakistan should be dealt in the country's perspective. High interest rate is strangulating economic growth thus employments without controlling inflationary public borrowing.