‘This is a cost-push inflation… it’s a rise in costs of fuel, which is something that is used in everything else. It’s used in the production of many many other goods and services, it’s used in transport, and so it doesn’t just affect the prices at the pump, it actually affects all others prices in the economy.
The problem is that then governments say, oh well, what we have to do is to get the central bank to tighten monetary policy, to raise the interest rates. That’s not the problem, that’s not the solution, that doesn’t affect the cause of inflation, so you really have to think of different measures in this situation. …The prices themselves have gone higher than you would expect given the actual impact on supply… and that’s because there’s been very feverish speculative activity in what are called the commodity futures markets.’ — An excerpt from a recent interview of renowned economist, Jayati Ghosh, by ‘Democracy Now’ news organization
Pandemic led to recession or recession-like situations in most parts of the world. While the rich, advanced countries, in general, were able to provide large fiscal injections and stimulus spending, on one hand, and vaccines at a much faster pace at the back of mainly through the practice of vaccine apartheid, on the other, in turn were able to rather quickly take the path of economic recovery, developing countries struggled on both these counts.
Moreover, whatever little fiscal injections/stimulus spending they could make, were mostly from their own resources, which included both using tax money and borrowing more. This added to the already difficult debt situation that many of these developing countries were facing.
The longevity of the pandemic (around two years have passed since the pandemic started) and little debt restructuring/relief by both rich, advanced countries and multilateral institutions like World Bank and International Monetary Fund (IMF), including providing little level of enhanced special drawing rights (SDRs) and continuing with collecting surcharges from programme countries that qualified for this, all added to financing pressures of developing countries.
In addition to pandemic, developing countries, especially those that were net importers of oil, had to face higher oil prices, which rather quickly bounced back from an earlier historic level dip during the first few months of the pandemic, whereby at the back of sharp and significant curtailment of oil supply, prices entered a rising path over the months that followed.
Then came the global commodity supply shock. The Russian invasion of Ukraine further contributed to supply constraints, and gave a chance for even more profiteering, which suppliers in general, sadly, seemed to have grabbed with both hands, accentuating in turn, inflationary pressures.
While the fight continues to manage macroeconomic situation by many developing countries, it is no secret that debt sustainability situation is fast dwindling in many parts of the global south in particular.
There could be a debt pandemic or debt defaults in many developing countries just around the corner, which should raise alarm bells for both rich, advanced countries and multilateral institutions. It is important to note that the climate change crisis is fast unfolding, and requires significant amounts of climate finance, which cannot be made in the wake of poor debt restructuring/relief and provision of climate finance.
Sri Lanka has already blinked with regard to managing debt situation. The country has defaulted on its debt payments, and is now trying to manage against a ‘hard default’, as an April 12 Al-Jazeera published article ‘Sri Lanka to suspend foreign debt payments’ pointed out in this regard: ‘Sri Lanka will temporarily suspend foreign debt payments to avoid a hard default, the governor of its central bank has said, pointing to the country’s limited foreign reserves that it needs to keep for imports of essentials such as fuel.
“It has come to a point that making debt payments are challenging and impossible. The best action that can be taken is to restructure debt and avoid a hard default,” Governor P Nandalal Weerasinghe told reporters on Tuesday.’ Moreover, a Financial Times (FT) article ‘Sri Lanka suspends bond payments as “last resort”’ indicated: ‘Sri Lanka’s finance ministry has suspended payments on its government bonds, breaking what it called its “unblemished record of external debt service since independence in 1948” in a deepening economic and currency crisis. …The country has a total of about $35bn in external government debt outstanding, with $7bn in payments due this year.
The IMF said last month that Sri Lanka’s public debt was at “unsustainable levels”.’
The strong surge in inflation is basically cost-push inflation at the back of supply constraints of commodities, mainly oil and food commodities, including the prices of urea for developing countries with big agricultural sectors.
Rather than fixing global supply chain bottlenecks through greater regulation of private sector and aggressively checking unjustified profiteering practices, unfortunately, however, the usual practice of increasing interests to curtail aggregate demand is being pursued, which means that higher cost of capital will make it difficult to make stimulus spending and climate-related investments, at a time when pandemic has acutely hurt growth rates, and active investments are needed to re-orient economies to meet the net-zero carbon emissions targets, where window of opportunity in terms of time is fast closing.
Hence, the wave of increasing interest rates, as is being seen in general, in both developed and developing countries, especially the countries that are under IMF programmes (where the IMF has traditionally underscored the need for taking the aggregate-demand squeeze channel, and continues to do so in many programme countries even in the current situation) has meant that the cost of capital has increased, putting greater pressure on current account, since meeting financing needs and attracting portfolio investment are becoming more expensive, and in turn mean greater interest payments and more pressure on foreign exchange reserves.
Increased interest payments have in turn made all the more difficult for developing countries to keep their debt situation sustainable. Therefore, continuing with taking the path of controlling inflation through the channel of increasing interest rates will most likely fuel it since undoing supply bottlenecks requires greater investment, which can only happen in one of the main ways, and that is through much cheaper capital.
Checking cost-push inflation and bring much-needed greater debt sustainability requires taking policy of decreasing interest rates, enhancing regulation, providing enhanced SDR allocation, and greater debt restructuring/relief.
The same line of argument also holds true in the case of Pakistan, which is suffering mainly from a wave of cost-push inflation at the back of global commodity supply shock, especially much-increased prices of food and urea, and higher oil prices, accentuating in turn the imported inflation component in overall high level of inflation.
Having said that State Bank of Pakistan (SBP) has been increasing interest rates for some time now, the recent such increases included a significant raise of 250 basis points in one go, taking the policy rate to 12.25 per cent. This is a wrong policy prescription for both keeping debt sustainable, and making the much-needed development expenditures/stimulus spending that the economy requires to continue with growth momentum after a difficult pandemic-causing-recession, and making it more inclusive.
Such growth momentum is also important for enhancing exports, increasing foreign exchange reserves and making debt situation more sustainable, on one hand, and on the other, in unlocking domestic supply bottlenecks, and checking excessive profiteering through greater supply and better governance/regulation, and overall bringing down the in-country cost-push inflation component. As indicated earlier, the same channel should be followed globally, rather than primarily relying on using the interest rate channel.
The recourse to latter channel could spell a catastrophe in terms of exacerbating hunger and poverty, since wrongly tackling inflation through primarily increasing interest rates would mean that higher interest payments would take a larger share of foreign exchange reserves into making external debt repayments, and will put greater pressure on domestic currency, making imports more expensive, especially oil.
It will add to inflationary pressures, and will further erode purchasing power; especially in view of the fact that real wages have not increased anywhere near as much as inflation. Also, the futures markets of commodities are already indicating much higher prices, raising in turn inflation expectations, and countries are already struggling to bring some sort of parity between wages and price increase.
Moreover, increasing interest rates would also take a lot out of domestic resources into making domestic debt repayments, and little would be left for stimulus spending, and in raising wages, which will be difficult for even private sector to do given their cost of production is already seeing a rise due to both very high imported inflation and rising domestic cost of capital, and will in turn have diminishing space for increasing wages.
The two years of pandemic that caused recession, and job losses on one hand, and high oil and food prices on the other, have acutely eroded purchasing power of people in developing countries like Pakistan. Poverty and inequality have most probably risen, in addition to political instability that for instance Pakistan is witnessing that will only add to economic pressures on people, not to mention the distraction it creates from focusing on difficult economic situation in terms of focused and aggressive policy.
Not internalizing the cost-push channel as the main driving force of inflation, significantly add to economic difficulties of masses. The severity of the situation with regard to inflationary pressures and poverty could be gauged, for instance, from a recent statement by Gabriela Bucher of Oxfam International as follows: ‘Without immediate radical action, we could be witnessing the most profound collapse of humanity into extreme poverty and suffering in memory’.
(The writer holds a PhD in Economics from the University of Barcelona; he previously worked at the International Monetary Fund)
Copyright Business Recorder, 2022