Managing Pakistan’s inflation

Globally, the spectre of inflation is back after a relatively benign period. The debate on how best to manage inflationary pressures remains divided, with the orthodox approach pushing for high policy rates and reduced liquidity with a dampening effect on economic growth.

Some feel that price pressures are transitory, and with economic expansion and the easing of supply chains, they will eventually fade away. Recent geopolitical uncertainties due to the Ukraine conflict are also resulting in a dizzying price rally in commodities.

Understanding inflation: Inflation adversely affects the lives of citizens and can put a speed limit on the growth of economies. We have learnt that inflation can arise from demand-pull and/or supply-push factors. Thus, the magnitude of underlying inflationary pressures may vary significantly across countries. Accordingly, policy responses to rising prices must be calibrated to the unique circumstances of individual economies.

In Pakistan’s case, high inflation is more about: i) weak economic fundamentals; ii) the global price pass-through with devaluation enhancing the price effect; iii) stockpiling by the government and suppliers; and iv) policy stimuli of concessionary financing during Covid, and expansionary fiscal stance including income support programmes.

Policy prescription: In this backdrop, we must be careful in advising inflation-targeting strategies. A rapid tightening of the monetary policy is not the only anti-inflation tool as it can excessively depress output and employment. Careful coordination of monetary and fiscal policies is required for both to pull in tandem. On the fiscal side, whereas the supplementary budget 2022 was to curtail demand, recent relief packages and intended new financing programmes need a cautious rethink.

Conducting a cost-benefit analysis and calculating the programmes’ inflationary impact before implementation is essential. Pushing sudden policies has hurt before and is likely to do so again. The current stance of the monetary policy with negative interest rates depends on a prudent fiscal policy along with other factors.

Sound calibration of these policies can tame inflation by dampening the aggregate demand in the economy. Repair of the fiscal side requires expenditure reforms both on the current and development side to ensure better value-for-money through government spending and reduce negative government savings.

Food-price inflation: Food-price inflation has the most direct effect on people’s lives, particularly in low-income countries like Pakistan. It is also the most complex problem to solve. We have not been able to address it over the years, increasing the country’s dependence on imported foods and agricultural raw materials. This neglect is deeply worrying, especially when food price inflation in Pakistan exceeds the rise in the overall consumer price index. Agriculture productivity in Pakistan stands at uncomfortably low levels at less than 50 percent of the world’s frontrunners in five staple crops – wheat, cotton, sugarcane, maize and rice.

A changed mindset is the right place to start. Efforts aimed at reducing prices through administrative measures have fallen on deaf ears. Policymakers must realise that the government’s involvement in the agriculture sector distorts markets. Meaningful work can redefine the role of the state in commodity operations – limited to maintaining strategic reserves, improving regulation and research.

Research spending should be raised from a meagre 0.8 percent of the GDP to at least two percent, correct incentives for improving cropping patterns and align universities and research organisations with farmers for improving yields. At the same time, marketisation can reduce reliance on exploitative middlemen, signal to producers to respond to changing market conditions, help in price discovery, and ensure timely imports and exports.

Fundamental repair: While interest-rate policies get headlines, there is so much more that needs to be done. Correcting the fundamentals is a sound way to manage inflation and deal with supply-side channels. These ideas have to be ingrained in an expansion of the country’s domestic productive capacity of industry, agriculture and services sectors. We cannot bear the expense of buying from international markets if we haven’t expanded our production. A higher GDP growth rate results in a faster increase in the domestic supply of commodities and thereby restricts price rises. Let us dwell on some key areas for repair.

An area of exceptional magnitude remains unaddressed – that of the transition of the energy sector. A state-dominated bleeding energy sector needs to be transitioned to a privatised energy market for capturing efficiency gains. Factors like new LNG terminals, the north-south gas pipeline, competitive gas pricing, cheaper local raw materials, and promoting a green energy transformation are the future. Implementing an energy efficiency and conservation plan and improving public transport systems can curb the excessive use of imported petroleum products. This transition implies new habits, behaviours and lifestyles. Mineral exploration in Pakistan cannot remain an elusive dream at a time of commodity price frenzy. It is a heavy agenda but one that we have to drive ourselves.

The state must set an example when it comes to reforms – especially when citizens’ expectations from the state are high due to their diminishing buying power. The FAO estimates that the global food import bill in 2021 would be the highest ever at more than $1.75 trillion, a 14 percent increase from 2020. Another significant factor is financial speculation in food markets, which has played a role in food price unpredictability. This means some low-income countries like Pakistan could be squeezed out of global food markets. We should be yearning to capture the gains from the precision agriculture revolution to increase sector productivity and ensure administrative action against hoarding.

Divestment agenda for efficiency in the rail, road, aviation, airports and transport sectors can give the supportive new infrastructure at competitive prices, without running excessive fiscal deficits. Realigning incentives away from real-estate has become imperative to channel domestic savings into productive assets. The former has seriously clogged financing for the stock market and the industrial sector. Spurring both domestic and foreign direct investment into productive sectors, through revamping the regulatory and investment climate, will help substantially. This is all serious hard work.

The challenge is to move beyond the artificial props of debt-funded spending and cheap money to create a more prosperous future for Pakistan – one based on businesses to expand the economy’s capital stock and make workers more productive with new equipment and skills. Fixing our woeful productivity is the only way to deliver sustained real wage increases for workers.

Goal: The thoughts outlined are real solutions and not fire-fighting measures. They go beyond the much-tried stabilisation agenda and highlight ideas beyond macroeconomic tools to tackle inflation. The thrust of initiatives is on reducing food inflation as it erodes the buying power of the vulnerable and urban middle-class, resulting in compromised spending for health and education.

Inflation is likely to remain elevated in 2022 in several countries; however, measures of inflation expectations for the medium- and long-term can be brought close to low policy targets for inflation. In Pakistan, our goal must be to manage the supply of commodities and cheaper fuels, improve the performance of competitive markets, ensure that there is no undervaluation of the rupee, and limit the rate of monetary expansion to a low double-digit rate. It is hoped that these actions along with work on the fundamentals will bring down the rate of inflation from 10 to11 percent in FY22 to around the intended five to seven percent in the coming years.

The writer is former adviser,

Ministry of Finance. He tweets @KhaqanNajeeb and can be reached at:

khaqanhnajeeb@gmail.com