Low interest rates are here to stay — at least till the end of this fiscal year — as the government is trying to lift the economy and the central bank remains committed to pursuing growth-promoting monetary policy.
But as economic recovery gathers pace with demand for goods and services growing, demand-induced inflation will be back. In 2019-20, the economy shrank 0.4 per cent as estimated by our own government and by 1.5pc according to the World Bank estimates.
Obviously, aggregate demand remained low during that year. Its exact extent will become obvious when the government comes up with revised data on GDP contraction. But inflationary pressures still persisted primarily due to supply constraints and high local energy prices. Energy prices are still on the rise as the government is addressing structural issues of the energy sector, including the circular debt, and as policy decision-making suffers from delays and short-sightedness. The output of industrial and services sectors is rising with recovery in aggregate demand — thanks to the Covid-19–necessitated fiscal stimulus package, low-base effect and expansionary monetary policy, a fact highlighted in the first quarterly report by the State Bank of Pakistan (SBP) for 2020-21.
Rising government borrowing makes little contribution to increased supplies
Rising energy prices will continue to fuel inflation. And, if the expanding industrial output is yet to meet the pent-up demand, demand-induced inflationary pressure will also be in sight.
The pace of economic recovery in 2020-21, in terms of exact GDP growth, will determine how much inflationary pressures can be felt in the economy. A wide variance in the SBP’s estimate of GDP growth of 1.5-2.5pc and the World Bank’s 0.5pc should not make much of a difference: both estimates are on the basis of different estimates of GDP contraction in the last fiscal year. And, the exact magnitude of energy price hikes will accordingly accelerate the current rate of inflation.
Even if agricultural sector performs better this year, increased domestic and export-led demand and higher energy prices will make it difficult to keep food inflation from rising, more so if smuggling and hoarding of food items continue.
So it would be naïve to expect food inflation in 2020-21 falling into single digits and overall consumer inflation not coming close to double digits. The SBP also believes that headline inflation can touch 9pc though it has also predicted a lowest-possible level of 7pc. But one must appreciate that the low-side projection could materialise only if the ongoing economic recovery proves humiliatingly short-lived. According to the Pakistan Bureau of Statistics, headline inflation in December 2020 was 8pc and food inflation stood at 12.6pc and 13.4pc in urban and rural areas, respectively.
In its latest quarterly report, the SBP has noted that “the slight increase in headline inflation” in July-September 2020 “was predominantly attributable to food inflation” but “the non-food, non-energy (NFNE) index remained subdued on the back of well-anchored inflation expectations.” But as the economic recovery gathers pace and demand for both food and non-food items goes up, even non-food, non-energy inflation will start inching up with some time lag. The only way NFNE inflation can come down is that the nascent economic recovery falters at some stage and the pace of recovery slows down.
Regardless of whether inflation rises further on the back of higher food and energy prices or due to a faster-than-expected economic recovery or both, people will suffer. And if the economic recovery cannot create enough jobs in the short run, which seems out of the question, their suffering will be excruciating.
The PTI government will find it hard to convince ordinary people that a high inflation is the price they are paying for reaping the benefits of economic turnaround with a time lag. After all, 220m “experience” inflation in terms of foregone expenses and forgotten wishes and only a negligible number of them “understand” what economic growth is and that it produces some inflation as well.
From a monetarist point of view, inflation is nothing but a monetary phenomenon and when low interest rates prevail for a few quarters they are bound to increase inflationary pressures later on because the very purpose of lowering interest rates is to encourage people to spend more and save less. When more money is spent and remains in circulation, productive sectors find it encouraging to boost production. But outputs grow gradually and systematically and not at once. So in the intervening period, we see prices moving up. That is happening now and will continue to happen at least till the end of this fiscal year.
The SBP has no magic wand to control inflation at a time when it is already busy ensuring monetary expansion for economic recovery. But the problem is the main driver for this monetary expansion still remains the government’s borrowing from commercial banks and not the banks’ net lending to the private sector.
In a little less than six months of this fiscal year (between July 1 and December 25), the government’s borrowing from banks rose past Rs1 trillion whereas the private sector’s net borrowing totalled just Rs118bn. Inflation can be checked more effectively if banks’ lending to the private sector is accelerated and the government contains its borrowing. Increased private-sector borrowing will help boost supplies of goods and services fast enough to stabilise prices. Increased government borrowing, in a mixed economy like ours with the private sector contributing far more to GDP growth, makes little contribution to increased supplies and is often used for settling old debts of its own or of state-owned enterprises.
The government has already cut down on development expenses — and, thus, there is little room available for promoting enough productivity in the economy via developmental projects.
Published in Dawn, The Business and Finance Weekly, January 11th, 2021
