FeaturedNationalVOLUME 18 ISSUE # 48

The unending battle against inflation

In Pakistan, the specter of rising inflation continues to cast a shadow over the economy, as job opportunities dwindle, businesses scale back, and prices surge. In the face of these economic challenges, both workers and companies are grappling with the profound impact of a 30% plus inflation rate. While some competitive firms have managed to provide limited compensation to their employees, the broader structural issues contributing to this inflationary crisis remain unaddressed.

Short-term inflation has reached a new peak for the fifth consecutive week, driven by a sharp increase in retail prices for petroleum products. As measured by the Sensitive Price Index (SPI), short-term inflation has surged by 38.28 percent year-on-year for the week ending on October 12. This marks the second-highest increase in the past five weeks and is primarily attributed to significant price hikes in electricity, petroleum products, LPG, and essential food items. This inflationary spike is expected to have a ripple effect across various sectors, notably affecting transportation.

Last week, the interim government slightly reduced petroleum product prices after three consecutive fortnights of price hikes, which had led to higher transport fares. The cost of moving goods has also risen due to the elevated fuel prices. This surge in prices follows a trend of high costs for electricity, petrol, LPG, and essential food items. Analysts anticipate a reduction in petroleum prices. However, transportation costs are likely to remain unaffected by any declines in petroleum prices due to the absence of a regulatory system. Short-term inflation increased by 0.3 percent compared to the previous week. Among the 51 items in the SPI basket, prices of 17 goods have risen, while 17 have fallen, and the prices of 17 items have remained unchanged from the previous week.

Pakistan is grappling with a significant issue related to an excessively high level of currency in circulation (CIC). Aside from causing other economic and societal problems, the consistent growth in CIC continues to fuel inflationary pressures, undermining the primary objective of interest rate tightening, which is to control inflation. The recent upsurge in inflation can be attributed, in large part, to the increases in energy prices. However, a persistently high share of CIC in the total money supply, standing at 39 percent as of June 2023, remains a consistent underlying factor. Headline inflation has risen sharply from 27.4 percent in August to 31.4 percent in September, marking a 400 basis point increase in inflation. This is a concerning development at a time when the country is already grappling with reduced demand due to a tighter monetary policy and ongoing reforms recommended by the International Monetary Fund, which tend to suppress demand. This situation hints at the underlying challenges of looming stagflation.

As import restrictions ease and multinational companies seek more freedom in repatriating profits and dividends abroad, the stability of the Pakistani rupee may be short-lived. Following last year’s meager GDP growth of 0.3 percent, this year’s growth is also expected to be insufficient to alleviate the poverty of a significant portion of Pakistan’s population, or to reduce the rising unemployment rate, which is estimated to reach 10 percent. The World Bank has recently forecasted a modest growth of just 1.7 percent for the fiscal year FY24, ending in June 2024, compared to the government’s initial target of 3.5 percent.

Inflation figures may seem like abstract statistics to Pakistan’s governing elite, but behind these numbers lie countless untold stories of suffering among the vast majority of the country’s 240 million people. A 31.4 percent annual inflation rate in September 2023 means that anyone who had an income of Rs100,000 per month in September 2022 now requires Rs131,400 to maintain their previous standard of living, while those earning Rs50,000 now need Rs65,700.

Presently, new job opportunities are scarce, and various industries and businesses are reducing their operations, leaving a portion of their workforce temporarily unemployed. Some competitive companies are attempting to compensate their employees for the effects of inflation, offering increases ranging from 10% to 15%. However, with an inflation rate exceeding 30%, this level of compensation is inadequate for both workers and businesses, including small enterprises.

Addressing the underlying issues contributing to high inflation, such as weak administrative controls, limited coordination between provinces and the central government, absence of fair market forces, low crop output, and reduced productivity among agricultural and factory workers, is not feasible in the short term. Additionally, controlling the issue of excessive currency in circulation will require more than one or two years. The government’s immediate option is to enforce fiscal discipline, while the central bank’s primary tool is further tightening its monetary policy. Whether the State Bank of Pakistan (SBP) opts for more tightening hinges on its assessment of whether inflationary pressures will persist in the coming months or if it believes that the inflation rate, currently at 31.4%, has already peaked and will gradually decrease.

The recent strengthening of the Pakistani rupee, which regained 7.6% of its value against the US dollar between September 6 and October 5, can be attributed to a crackdown on hoarding of US dollars and unscrupulous exchange companies, supported by the military. Moreover, starting from October 1, the caretaker government has marginally reduced domestic fuel prices. These actions might help alleviate inflationary pressures in October, particularly if the crackdown continues and if international oil prices ease, allowing local fuel prices to remain stable for a few fortnights.

However, controlling food inflation remains a significant challenge for the government due to a collapse in the system of enforcing administrative controls on prices of essential but price-inelastic food items. Although food inflation has decreased from its August 2023 levels of 38.8% and 40.6%, it still stands at 33.9% in urban areas and 35.4% in rural Pakistan. One contributing factor to this inflation is the overshooting of fiscal targets.

Sustaining the gain in the rupee’s value could lead to lower domestic and external debt repayments in rupee terms, enabling resources to be redirected towards productive sectors, addressing cost-push factors of inflation. Additionally, this could reduce the impact of imported inflation. Nonetheless, as import restrictions are gradually lifted, and multinational companies in Pakistan push for more freedom to repatriate profits and dividends abroad, the rupee’s upward trend might be short-lived. It is crucial to remember that the country’s foreign exchange shortage is a structural problem.

During July-September 2023, the country’s goods exports amounted to only $6.9 billion, while imports, despite a significant slowdown compared to the same period in 2022, reached $12.2 billion, resulting in a trade deficit of $5.29 billion. Data on remittances for July-September are still pending, but in July-August 2023, overseas Pakistanis sent around $4.12 billion back home, a 21.6% decrease compared to the same period in 2022. Without a rapid increase in exports and a resumption of remittance growth, financing import bills with the combined earnings of goods exports and remittances would be unfeasible, widening the anticipated external financing gap and potentially weakening the rupee, reigniting inflation.

Pakistan faces a daunting economic battle as it contends with stubbornly high inflation, structural issues, and external pressures. While the recent efforts to strengthen the rupee and marginally reduce domestic fuel prices offer some hope, the long-term challenges of restoring fiscal discipline, addressing administrative controls, and reviving key sectors of the economy remain formidable. It is clear that without a concerted effort to bolster exports, encourage remittances, and tackle the country’s structural foreign exchange shortage, the rupee’s gains may prove short-lived, and the inflationary storm will continue to loom large over the nation’s economy. These economic struggles are not just statistics; they represent the hardships of millions of Pakistanis. The road ahead is fraught with challenges, but with a multifaceted approach and a commitment to reform, Pakistan can aspire to a more stable and prosperous future.