DEMAND & SUPPLY SIDE INFLATION
SAAD ANWAR HASHMI
June 18 - 24, 2012
Probably the biggest challenge faced by Pakistan currently is inflation, which is pushing the population below the poverty line causing numerous economic problems and lawlessness. There have been frequent protests against inflation, which increases cost of living and cost of foods especially for low-income group.
The inflation is driven through demand and supply side pressures, however it is difficult to ascertain the degree to which either supply or demand or both have contributed to constant increases in inflation witnessed in an economy. The state bank of Pakistan (SBP) carries out strict measures to control the money supply in Pakistan to reduce inflation. However, there seems to be major misalignment between both monetary and fiscal measures to reduce inflation.
Inflation rate in Pakistan is expected to remain above 12 per cent through CY12 and has been in double digits since 2003. Based on the latest inflation monitor report by SBP issued in April 2012, inflation is on a rise among all income levels and across most commodities and products used for daily consumption. Major increases have been witnessed among wheat, pulses, eggs, milk, sugar, fruits, and vegetables which will continue to be volatile. Consumer price index (CPI) is recorded at 12.3 per cent as on May 2012, one of the highest in the region. The reasons for inflation in Pakistan are numerous some driven through supply while others driven through demand side pressures.
Constant rise in prices of fuel not only increase cost of production but also cost of transportation, which affects the price of commodities across the board. Based on the understanding of those involved in day to day street business, any increase or decrease in the price of fuel does not translate into an equivalent percentage increase or decrease in the price of commodities, which means that the price will be volatile considering the cost of inputs. There is no authority, which effectively monitors exponential or justifiable increase or reduction in the price of commodities. Therefore, no effective price control mechanism exists, which is a cause of concern.
Despite measures undertaken by the SBP to control money supply, the government remains the single largest borrower from the banking sector through fixed income securities for deficit financing, which again increases inflation. The government borrowings as on May 2012 amounted to Rs1,660 billion, which resulted in crowding out private sector. Budget deficit is expected to remain below five per cent of GDP in next fiscal year.
Remittances stand at an average one billion dollar per month. Though increase in inflows is seen positive to build reserves, further increases can push up money supply and thus inflation. As per expectations, the trade deficit is expected to remain between $14 billion to $15 billion through FY12-13.
Pakistan is a net importer. Unabated fall in rupee value against the US dollar may bring parity 100 a dollar, which means further rise in prices. Though there is a pressure on rupee, GDP is expected to grow and remain between 2.6 per cent and three per cent through FY12, which again is seen as a cause for inflation creating a demand and supply gap. Growing population of Pakistan results in demand-driven inflation.
The measures to control inflation through both demand and supply measures may only be possible if stringent measures are undertaken to control the budgetary deficits through an increase in tax base (both direct and indirect taxation) which will reduce the need for government borrowing.
With reduction in government borrowing from the banking system, interest rates will come down, which would encourage companies to borrow debt for new initiatives and expansion. A price control mechanism should be in place, which monitors the volatility in price of commodities to ensure that selling price and costs are justifiable.
The core purpose of the monetary policy is to control excess supply of money to manage inflation whereas fiscal measures are centered around increasing the tax base. The government makes an effort to increase GDP while inflation is manageable. Double-digit inflation as witnessed in Pakistan with net returns on deposits between four to five per cent results in negative returns considering the cost of living. The government has taken measures to provide subsidiaries to boost agricultural output. However, the subsidiaries have not translated into reduction in price keeping with increases in cost of other inputs.
The monetary policy structured by SBP may only be functional if the monetary policy decisions are aligned with the fiscal policy to keep a check on inflation. These challenges are not impossible to achieve. However, only time will tell how such challenges may be met to ensure economic growth keeping inflation at manageable levels.