Inconsistent decision-making, bureaucratic inertia, negative growth of large-scale manufacturing in the July-November period and state borrowing from the SBP are leading to the nightmare of too much money chasing too few goods
On Friday February 1, Pakistan Bureau of Statistics (PBS), the official source of information on inflation measured by the Consumer Price Index (CPI), announced the rate of inflation for the month of January. It does that on the first day of every month. The latest announcement, however, set the alarm bells ringing as inflation touched 7.2 percent, the highest in the last four years.
While restraining individual price hikes is a matter for various levels of government, controlling inflation is the responsibility of the State Bank of Pakistan (SBP). Monetary policy is the tool in its hands. A day before the PBS announcement, Monetary Policy Committee (MPC) of the SBP met and decided to increase the policy rate from 10 to 10.25 percent, or by a mere 25 bps.
The question is: Would the MPC decision have been the same, had it waited for another day? While the CPI information is always made available at the start of the month, the MPC does not have to meet on the last day of the month. In the past, it has been meeting in the middle of the months and other dates. It should have full information before it. On January 31, the information considered by the MPC for average headline CPI inflation was for six months, which stood at 6 percent, "considerably higher than the 3.8 percent recorded during the same period last year." Now it is 6.21 percent against 3.85 percent.
It was also noted that "headline YoY inflation has shown some moderation during the last two months." The moderation has given way to a jump to 7.2 percent in January. The only concern was "core inflation as measured by non-food-non-energy components of the CPI basket" reaching 8.4 percent in December 2018. The core concern is up at 8.7 percent.
On the whole, it was concluded that "the projected range of inflation remains unchanged at 6.5 to 7.5 percent." The top of the range is approaching fast. In the last fiscal year, average headline inflation at 3.8 percent remained lower than the SBP’s target of 6 percent. In the current year, inflation is threatening to beat the SBP’s projections.
Both headline and core inflation are entering the red zone. De-composition of the headline inflation of 7.2 percent reveals that the highest increases are the result of official policy. Non-perishable food items have the highest weight of 29.84 in the CPI. Most of these items have become expensive due to the massive devaluation of the rupee. Out of 7.2 percent increase in headline inflation, this group contributed 1.48 percentage points.
Housing, water, electricity, gas and fuels group has the next highest weight of 29.41 percent.The group contributed 3.13 percentage points to the headline inflation. Gas prices were first hiked to demonstrate the hard stance of the government towards subsidies and losses. As the harsh winter set in, the bills ballooned, in some cases, larger than house rents. Now the government is inquiring into why it did what it did.
Gas price shot up by 85.31 percent. Other increases in the group were also in double-digit: Motor fuel (18.05 percent), kerosene oil (16.14 percent), water supply (12.94 percent). Electricity price rose by 8.48 percent, but the recent proposals to increase tariff will impact upon the headline inflation in February. House rents increased by 8.2 percent. Related to rising fuel cost, transport contributed 0.89 percentage points to the headline inflation, the third highest, with an increase of 15.22 percent.
Sensitive Price Indicator (SPI) is a subset of CPI, consisting of 53 essential items. Before the PTI government was installed, the SPI suddenly rose from 0.5 percent in May to 1.9 percent in June and went up to 3.6 percent in July. It started to decline thereafter as the new government raised expectations of a better future in its honeymoon period. The SPI was 3.3 percent in August, fell to one percent in September, but started to increase again since October. By January, it stood as high as 3.7 percent. This is for the lowest income quintile. For all five quintiles, the SPI in January is 6.67 percent, closely following the headline CPI.
On a weekly basis, the situation is much worse. For the week ending on January 31, 2019, the SPI was 5.26 percent for the lowest income quintile and 8.89 percent for all quintiles combined.
It seems that the SBP was caught up in the battle of macroeconomic frameworks between the Ministry of Finance and the Planning Commission. Traditionally, the Planning Commission pushes for growth and, therefore, cares less for inflation. The Ministry of Finance claims to stand for stability, but is hungry for resources to meet its current expenditure. This it does by curtailing development expenditure. And this is what happened at the meeting of the Monetary and Fiscal Coordination Board, held the day before the MPC meeting.
In theory, the SBP is independent in its decision-making. In effect, this board, provided in SBP law and chaired by the finance minister and membered by planning and commerce ministers, besides two independent professionals and the governor, is the arena to coordinate economic policies. This concourse signaled the beginning of the end of doom and gloom in the wake of the inflows from friends and the "no need to go the IMF" mantra.
A higher interest rate would tarnish this feel-good message. The MPC, not exactly a collection of experts in the monetary field, decided to lie low. It played safe by announcing a marginal increase in the policy rate, but was able to not fall fully in line to go for no change or a marginal decrease.
The trouble is that the twin deficits, fiscal and current account, that are the main sources of rising demand pressure, continue to be problematic. While the FBR was falling way behind the first mini budget targets, the second mini budget dole-outs to the rich and the powerful have dug another hole in the revenues. What was billed as a reform package said nothing about getting rid of the deadweight called the FBR.
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To reduce its cost of borrowing, the ministry of finance has retired its commercial bank debt by borrowing from the SBP. This is classic printing of currency notes providing maximum fuel to inflation. Credit to private sector, as a result, has seen some boost, but not to fixed investment that has actually declined. In the case of current account deficit, the competitive edge provided by rupee depreciation is being eroded by the rising domestic inflation.
Uncertainty, inconsistent decision-making, bureaucratic inertia, gloomy outlook for agriculture, negative growth of large-scale manufacturing in the July-November period and state borrowing from the SBP are leading to the nightmare of too much money chasing too few goods. Deliberate inflation creating jobs may be tolerable, but the present inflation, in the words of a French economist, "consists of subsidising expenditures that give no returns with money that does not exist."