First it was vaccine apartheid practiced by many rich, advanced countries, which significantly contributed to an uneven global recovery. This, along with huge amounts that the rich, advanced countries were able to inject allowed them to recovery a lot faster than many developing countries.
Then it was the global commodity supply shock, both due to the pandemic but also because of war in Ukraine by Russia, along with high prices of oil at the back of both demand pickup as a result of recovery, but also meaningfully because of supply constraints applied by OPEC+ group of countries overall, became a leading factor for inflationary pressures globally. Here, in the rich, advanced countries in general, inflation has apparently been caused by increase in aggregate demand at the back of significant stimulus spending and from the rise in oil and food prices.
On the other hand, in developing countries, especially in countries that are net importers of oil, like Pakistan, which also import commodities like wheat and fertilizer, among others, have seen significant increase in inflationary pressures mainly from the increased component of imported inflation.
So the policy response needs to be a good mix of austerity and counter-cyclical economic policies where, on one hand, it is important to reduce current expenditures and postpone less-important development expenditures and, on the other hand, the impact of oil prices, for instance, is reduced by providing a rational subsidy, lower taxes as much as possible, and also rationalizing other components of its price makeup.
Oil is possibly the leading causal factor in net oil importing developing countries, feeding into prices of a vast array of goods and services; so it is important to reduce its price for domestic consumers. A marked reduction in its price is also necessary for generation of electricity.
The pandemic and inflationary pressures have had very difficult growth, poverty, and inequality consequences for developing countries, including Pakistan, because there was no significant provision of debt moratorium/relief, very little allocation of enhanced special drawing rights (SDRs) by the International Monetary Fund (IMF) and less than satisfactory provision of climate finance. All of this significantly contributed to difficulties for developing countries in terms of keeping the fiscal, current account, and debt at sustainable levels.
It will make sense for the current government to actively pursue economic diplomacy with creditor countries, and multilateral institutions, so that external debt burden, which is around 31 percent of GDP (and together with domestic debt stands at around 95 percent of GDP) could be reduced through much greater debt relief/moratorium.
Here, the government should also take up with US Federal Reserve and IMF – as newly appointed Finance Minister is going on a visit to Washington to hold meetings with IMF – for additional release of SDRs, in addition to the $2.75 billion that were released as Covid related assistance in last August. This may be done through advocacy by IMF officials with rich countries to relocate some portion from their enhanced SDR allocation from last August.
Moreover, the recent increase in interest rates globally indicates quite strongly that the world as a whole has not understood that the current inflationary pressures have a very strong influence in the shape of cost-push inflation, and not demand-pull inflation, and tightening of monetary policy stance will likely add to significant growth sacrifice, and in turn, job loss, for very limited macroeconomic stability.
Hence, since inflation strongly appears to be mainly cost-push in nature, therefore it will make sense that policy rate may be revised down to single digits. Currently the real interest rate is almost zero, but given the supply-driven nature of inflation mainly, it would make sense for State Bank of Pakistan (SBP) to lower policy rate.
Lowering the interest rate is important to both rein-in as much as possible the interest payments on domestic debt (which currently stands at around 62 percent of GDP), and also, bring greater sustainability to an economic growth momentum that was reached last year, since higher cost of capital will likely reduce investment. Fiscal space is also needed in turn for providing subsidy on oil, energy, and essential items, which contribute significantly to overall inflation in the country, and cause a lot of hardship for the poor, especially in the wake of the pandemic.
Monetary policy tightening stance being adopted by the developed countries also needs to be in a less than aggressive way, given inflation everywhere has a very strong supply-driven emphasis, and also because rising interest rate in rich, advanced countries is already causing a flight of foreign portfolio investment from developing countries. This will meaningfully add to depreciating consequences on local currencies of developing countries, adding in turn to the imported component of inflation and will significantly contribute to their already high debt pressures.
The current government, which is in negotiations with IMF with regard to the ongoing programme, needs to highlight these issues, and tone down the austerity and pro-cyclical emphasis of IMF in the light of these and other arguments.
Growth momentum has been achieved after a lot of growth sacrifice of the initial phase of the programme and also due to the recession-causing pandemic, and it is important to continue with a rationalized level of subsidy, stimulus, and a much less-tight monetary policy stance. Understanding by IMF on these lines is also important because economic instability has already contributed to political instability in a meaningful way; for instance in the case of Sri Lanka, and a rather less way in Pakistan.
(The writer holds a PhD in Economics from the University of Barcelona; he previously worked at the International Monetary Fund)
Copyright Business Recorder, 2022