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Inflation is largely an outcome of government policies ranging from an unsustainable budget deficit to heavy domestic borrowing by the government (which may crowd out private sector borrowing that, in turn, may lower domestic productivity) to an eroding local currency (that would make imports expensive) to a rise in demand against limited supply to a rise in the costs of production (rent, tariffs, inputs including borrowing costs) – policies recommended by economists in some concerning economic scenarios, albeit in measures that are strictly monitored and controlled.

In Pakistan, these measures have been monitored and dealt with only during the time the country is on an International Monetary Fund (IMF) programme and once the programme is completed the country’s economic managers have reverted back to the previous unsustainable policies. In the current twenty third IMF programme the Fund staff is clearly unwilling to let the status-quo of previous programmes prevail and is insisting on some policy reforms that are, with government support, hitting the poor more than the rich.

The question is which one of the elements responsible for inflation in Pakistan can be tweaked by the latest set of economic team leaders to check the rise in inflation if not reverse it?

Today two administrative measures are the major contributors to inflation. First, the steady rise in reliance on petroleum levy to generate federal revenue, a reliance sourced to the fact that this levy is not part of the divisible pool implying thereby that the federal government gets to keep the entire amount without having to share it with the provinces.

The government has legislated 50 rupees per litre petroleum levy with the objective of generating 750 billion rupees for the entire year against 650 billion rupees budgeted last year – or a rise of 23 percent in a year where the projected Gross Domestic Product is 2 percent against last year’s 6 percent.

Petroleum levy is an indirect regressive tax and its incidence on the poor is more than on the rich. It directly affects the prices of all transport – public and private, road and air, including transporting consumer items from farm to markets as well as industrial products both within the country and those destined for ports abroad. What is relevant in this context is that Pakistan’s economic managers, present as well as past, have been unable and/or unwilling to change the tax structure that remains grossly tilted in favour of the elite and continue to rely on low hanging fruit, read indirect taxes, for revenue.

The failure to end elite capture of the country’s limited resources is evident in not only not amending the constitution that renders farm income a provincial subject but also the failure of all provincial governments over time to impose a farm tax comparable to the income tax payable by say the salaried with much lower incomes; and monetary and fiscal incentives as well as tariff subsidies continue to large production units with the reported objective of raising total exports or encourage growth while no study has yet been undertaken to ascertain the actual benefits/outcome of such expensive incentives.

The second administrative measure that accounts for inflation today is the price of electricity. Government after government subsidizes electricity for the poor and vulnerable (defined as the subsistence consumers) as well as the export sector with the newly-appointed finance minister Ishaq Dar agreeing to provide electricity at 19.99 rupees per litre to the five export-oriented sectors at a cost of 100 billion rupees to the taxpayers. This decision is at odds with the agreement by Dar’s predecessor in the IMF’s seventh/eighth successful reviews.

The relevant head of department that deals with Pakistan Azour stated during a press conference on 13 October 2022 that subsidies must be targeted: “on the issue of subsidy, as in other parts of the world, subsidy that is targeted to support certain items has proved not to be very effective. I would say it has proved to be very regressive.

And in our regional economic outlook we are again looking at this issue that is showing that this is not the best way to use the very limited fiscal space that exists. Therefore, we are encouraging Pakistan as well as also other countries to move from an untargeted subsidy that is a waste of resources and to dedicate those resources to those who need it. I give you one simple example. The region spends on social protection 2 percent of GDP and in certain cases what countries are spending on subsidies could be the double of that.”

In spite of the devastating floods which necessitated the release of assistance to the victims through the Benazir Income Support Programme (BISP) the government has yet to update its budgeted expenditure outlays. BISP was budgeted at 3.78 percent of total expenditure - 360 billion rupees - though this amount has not been revised upward given the cash disbursements to the flood victims with one-third of the country inundated.

And what is even more disturbing and inflationary is the reliance on borrowing both externally in the current year (40 plus billion dollars) and domestically (with bank borrowing budgeted at 1.172 trillion rupees though this is likely to be surpassed as between 1 July to 14 October the government had already borrowed 608.5 billion rupees – 52 percent of the amount budgeted for the entire year).

And what is the most baffling about the power sector crisis is that the onus of appallingly poor governance and incompetence, poorly negotiated contracts with independent power producers, including under the China Pakistan Economic Corridor umbrella, and the lack of focus on all issues (notably a focus on generation as opposed to the limited transmission capacity) has fallen on the general public. Thus as energy price is raised, with a significant political cost, government after government agrees to up the electricity prices to achieve the multilateral objective of full cost recovery.

Be that as it may, decisions taken by the incumbent finance minister may well delay the ninth review success, as was the case with the two previous finance ministers, which in turn would put further pressure on the foreign exchange reserves that have dwindled to 7.8 billion dollars as of September 22 with implications on the rupee value. As the rupee value erodes the cost of all imported items would rise particularly petroleum and products, wheat (unless subsidized) and other non-luxury imported items in use by the general public.

The budget deficit is yet another source of inflation. While during the Khan administration the deficit remained unsustainable at well over 7 percent and was unrealistically budgeted at 4.9 percent for the current year - a target rendered all the more unrealistic after the floods and Dar’s penchant for disbursing subsidies as well as fiscal and monetary incentives to the elite.

Pakistani administrations in their indefatigable desire not to alienate their electorates do alienate large parts of those very electorates through continuing to focus on the elite, able and willing to use their influence and street power, rather than on the large number of poor, lower middle and middle income earners as therein lies the low hanging fruit. This needs an urgent revisit.

To conclude, the government in the very short term can immediately reduce inflation by slashing expenditure – preferably current expenditure – which would not only reduce the money in circulation, thereby dampening inflationary pressures but also create some leverage with the Fund to renegotiate some of the harsh upfront conditions in the ninth review.

Copyright Business Recorder, 2022


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