TIGHT MONETARY POLICY FAILS TO TAME INFLATION
June 18 - 24, 2012
Traditionally, monetary policy is an instrument of macroeconomic stabilization. However, the matter to ponder upon is whether it has actually helped in lowering inflation and promoting growth in developing economies.
The outcome in this context is not promising for Pakistan, which is trapped in the predicament of high inflation and low growth. The state bank of Pakistan (SBP) by following tight monetary policy stance has increased the discount rate to curtail inflation. But, this policy has failed to deliver the desired results as inflation has reached an uncontrollable level in the country.
Normally, a tight monetary policy approach is workable in a rapidly growing economy to obstruct the rise in prices. In Pakistan's scenario, we need to broaden the economic base and adopt a growth-oriented policy. The present economic growth has slowed down due to tight monetary policy, which has upended the process of economic recovery. As a matter of fact, the increase in discount rate should restrain the government borrowing level, but such is not the case in Pakistan.
Inflation has emerged a critical burning issue for the country that has social and political consequences and it leads to enhancement of poverty. The analysis of last few years clearly shows that the SBP's tight monetary policy has failed to bring down inflation caused by increased fuel, food and power prices, and exchange rate depreciation. The economic managers need to take fiscal and administrative measures to deal with inflationary pressures.
Double-digit inflation pushes more people below the poverty line in the absence of any significant economic activity, which has been hurt by poor law and order situation. Business community has been demanding lower interest rates to promote private sector investment and stimulate the economy.
Increases in electricity, gas and the petroleum product prices have already hurt business and industry and the double-digit interest rate is creating more problems for entrepreneurs by depriving them of affordable financing.
The cash-strapped government's failure to cut expenditure, broaden tax revenues, and fix structural flaws in the economy is jeopardizing stability and growth. It missed most of the fiscal targets for the financial year, lived on borrowed money, and let the fiscal deficit swell and price inflation spike.
Pakistan has one of the world's highest benchmark interest rates. Inflation, devaluing currency, reduced per capita income, war on terror, worst energy crisis, poor governance, and high political instability are some of its major issues affecting its economy. These factors are leaving a huge impact on all sectors of its economy. Cost of doing business has significantly risen due to extraordinarily high interest rates.
Inflation edged up by 10.8 per cent in March year on year because of increase in fuel and manufactured products prices. The inflation, measured through the consumer price index (CPI), rose by 1.2 per cent in March as compared to an increase of 0.3 per cent in February, figures released by Pakistan Bureau of Statistics (PBS) said.
Inflation rate refers to a general rise in prices measured against a standard level of purchasing power. In the past one decade, the average inflation in Pakistan was reported at 10.15 per cent. Stubbornly high inflation will be a policy challenge for the incumbent government in an election year when a reverse trend in prices was witnessed since December last year.
Global commodity and crude prices have also shot up fuelling inflation further in the domestic market. The surprise turnaround in prices put the government end-year projection target of nine per cent at risk and mounting pressure on the central bank to increase interest rates remained unchanged for the past few months.
The central bank kept the interest rate unchanged at 12 per cent. The core inflation, excluding food and energy, rose to 10.8 per cent in March from 10.6 per cent in February, making a strong case that the central bank may go for increasing interest rate to contain inflation.
For the first nine months, inflation reached 10.79 per cent, slightly over the government annual target of 9.5 per cent. However, PBS official said that government has revised its annual inflation target to 12 per cent.
At the same time, a weaker rupee will fan inflation, which is already lost over six per cent in the past few months. The state bank seems reluctant to intervene in the market to check the fall of the rupee. But, contrary to this, food inflation recorded a single digit growth of 9.81 per cent in March year on year. As a result, prices of non-perishable food items witnessed a surge of 9.02 per cent and that of perishable items 14.82 per cent.
In the food basket, the prices of onions were up by (44.93 pc), gram whole (33.27 pc), pulse gram (32.57 pc), condiments (29.06 pc), besan (24.38 pc), fresh fruits (22.54 pc), spices (21.30 pc), eggs (20.18 pc), betel leaves and nuts (18.56 pc) and milk products (18.03 pc) in March 2012 over the same month last year.
And in the non-food basket, the motor vehicle tax increased by (52.02 pc), household servant (32.48 pc), kerosene (29.86 pc), gas (29.41pc), motor fuel (27.53 pc), firewood whole (26.46pc), personal equipment (25.48 pc), woollen cloth (25.11 pc) and medical equipment (21.29 pc)
"Agriculture is fast becoming unaffordable and unattractive for majority of the farmers, and their meager income is not enough to invest in modernisation of the farm economy," farmers said.
According to them, the budget must focus on small farmers and ensure efficient marketing system for their produce. In a situation where cost of production has increased manifold, marketing system is flawed and farmers lack price support (getting less than official price), farming ceases to be profitable occupation for many.
They further said the rising cost of production was resulting in fall of agriculture output. The government needs to invest in water harvesting, water/soil conservation, land development, mechanised farming, hybrid technology, water management, and agriculture and livestock research and extension, capacity building of farmers and agriculture scientists. But, all these sectors are still a low priority, they added.
Experts said that movements in interest rates affect the overall level of demand in the economy and therefore can have a powerful influence on the inflation rate. Other things being equal, a rise in base rates (short-term interest rates) will tend to dampen demand. A fall in rates will boost aggregate demand, and so put upward pressure on the inflation rate.
Analysts said that interest rates have to be reduced in order to tackle this situation as the business sector is suffering tremendously. Inflation is another very important factor in determining the interest rates. Investors want to preserve the "purchasing power" of their money. If inflation is high and risks going higher, investors will need a higher interest rate to consider lending their money for more than the shortest term. The high interest rate is the main reason behind the fall in the country's industrial output.
Cutting interest rates to a single digit will produce multiple benefits for the economy, as it will lower the cost of doing business, give a strong boost to business and industrial activities, provide easy credit and loaning facilities to trade and industry, promote better investment and exports, and generate more tax revenue for the government.