fter exhibiting some tentativeness, the new government has resolved to stay on and will be presenting the annual budget on June 10. Negotiation with the International Monetary Fund will continue in Doha over the next week. In the first round of talks, the IMF has made it clear that it will not release more funds unless and until subsidies on petroleum products are ended and prices raised. The government appears to be in a fix. It faces a serious politics-economy trade-off.

Given the political as well as economic uncertainty, it is hard to predict what the upcoming budget will look like or to suggest what it should be like under the circumstances. The outcome of negotiations with the IMF will be its primary influencer. If the parties agree to a reform programme, not much relief can be expected in the budget as stringent IMF conditionalities will leave little room for subsidies and tax breaks.

Some relief could still come in the forms of social protection programmes and tax cuts on green energy alternatives. If the past record of the current prime minister is any guide, increased spending can also be expected in health and education sectors.

Taxes are likely to increase in case of an agreement with the IMF. The IMF wants the budget to be designed to reduce the fiscal deficit which rose to 4.0 percent of the GDP during the first nine months of the current fiscal year from 3.0 percent (on the basis of revised GDP) last year.

Import tariffs may also rise drastically as an alternative to a complete ban on imports. The ban on import of luxury items may not continue beyond two months.

Responsibility

While the current government is to blame for not making quick decisions, some of the economic uncertainty today is on account of the actions taken by the previous government, particularly, the prime minister’s energy relief package which has led to an increase in the fiscal deficit by necessitating more borrowing. It will also lead to a bigger import bill by increasing demand for petroleum products. According to Oil Companies Advisory Council (OCAC), anticipated price promoted speculative buying of fuel. The import bill for April 2022 jumped amid a 72 percent year-on-year jump in Arab Light crude prices and a 28 percent year-on-year volumetric growth. This jeopardised the outcome of the seventh review of the IMF programme.

The IMF statement issued on May 25 (after Doha talks) clearly says that “On the fiscal side, there have been deviations from the policies agreed in the last review, partly reflecting the fuel and power subsidies announced by the authorities in February.”

The incumbent government has contributed to a worsening of the situation through its indecisiveness. Clarity on economic agenda and a well planned and communicated roadmap to achieve its goals would have helped defuse the panic.

Now that the government has ruled out early elections, its focus should be on striking a good deal with the IMF so that the budget does not unnecessarily burden the working class. Most of the burden should be passed to those who can afford it, for example, by raising taxes and lowering amnesties on real estate.

Some of the economic uncertainty today is on account of the actions taken by the previous government, particularly, the prime minister’s energy relief package which has led to an increase in the fiscal deficit by necessitating more borrowing. It will also lead to a bigger import bill by increasing demand for petroleum products.

Inflation outlook

The inflation is likely to remain high. The May 23 monetary policy statement of the State Bank of Pakistan says headline inflation is likely to increase temporarily and may remain elevated throughout the next fiscal year. It may balloon further after the budget.

If negotiations with the IMF succeed, the government might need to increase fuel prices. On the other hand, if the government does not agree with the IMF on fuel prices, there will be increasing pressure on the rupee amid depleting foreign exchange reserves, rising import bill and surging financing needs.

Global factors will also have a significant role in the inflation outlook. The Russia-Ukraine War will lead prices of commodities like wheat to shoot up. The expected recovery in the Chinese market will also induce a demand pressure in the international market.

Considering these factors, the inflation will likely remain in double digits throughout the year. The recent IMF report has predicted the inflation rate for the current year to be 11.2 percent. It has estimated inflation levels to be near 10.5 percent for the following year.

The SBP role

The State Bank has a vital role to play. It has the primary responsibility to deliver “low and stable” inflation in the country. This was highlighted in their recent monetary policy statement, when the interest rate was increased by 150 bps in an attempt to “cool down the economy.” According to the statement, the growth rate is likely to slow down and settle between 3.5 and 4.5 percent in FY2023. This and other factors will reduce the demand pressure.

It is crucial for the SBP at this point not to rely entirely on the policy rate as its sole instrument in tackling inflation. If the interest rate keeps increasing at the present pace, it could become counter-productive. The SBP should come up with an effective communication strategy to manage inflation expectations and market confidence.

The SBP and the government need to work closely, especially after the budget, to control inflation. This is because both institutions will play an essential role in how inflation is controlled, e.g. in the case of setting new taxes or an altogether new policy.

The SBP also needs to closely monitor the fiscal policy to make effective decisions to control inflation. In the event of an expansionary fiscal policy practiced by the government, the Bank needs to use its instruments effectively not to let inflation levels go up.

Quick measures

Price control committees at district level need to be effective to look into problems like hoarding, profiteering and smuggling of commodities and quickly find solutions for them. These practices induce shortages in the market and lead to rising price.

For as long as inflation remains high, the vulnerable population (bottom 40 percent) in the economy needs to be supported by the government on an emergency basis. There is a need to increase their purchasing power. This could be done by increasing social protection spending.

Also, if the government decides to cut fuel subsidies, it should do so gradually, as an immediate increase will impose an extreme burden on the society. The government should also compensate the poor through cross-subsidies.

The writer is the deputy executive director at the Sustainable Development Policy Institute (SDPI). The opinions expressed here do not reflect SDPI’s position.