AIRLINK 69.92 Increased By ▲ 4.72 (7.24%)
BOP 5.46 Decreased By ▼ -0.11 (-1.97%)
CNERGY 4.50 Decreased By ▼ -0.06 (-1.32%)
DFML 25.71 Increased By ▲ 1.19 (4.85%)
DGKC 69.85 Decreased By ▼ -0.11 (-0.16%)
FCCL 20.02 Decreased By ▼ -0.28 (-1.38%)
FFBL 30.69 Increased By ▲ 1.58 (5.43%)
FFL 9.75 Decreased By ▼ -0.08 (-0.81%)
GGL 10.12 Increased By ▲ 0.11 (1.1%)
HBL 114.90 Increased By ▲ 0.65 (0.57%)
HUBC 132.10 Increased By ▲ 3.00 (2.32%)
HUMNL 6.73 Increased By ▲ 0.02 (0.3%)
KEL 4.44 No Change ▼ 0.00 (0%)
KOSM 4.93 Increased By ▲ 0.04 (0.82%)
MLCF 36.45 Decreased By ▼ -0.55 (-1.49%)
OGDC 133.90 Increased By ▲ 1.60 (1.21%)
PAEL 22.50 Decreased By ▼ -0.04 (-0.18%)
PIAA 25.39 Decreased By ▼ -0.50 (-1.93%)
PIBTL 6.61 Increased By ▲ 0.01 (0.15%)
PPL 113.20 Increased By ▲ 0.35 (0.31%)
PRL 30.12 Increased By ▲ 0.71 (2.41%)
PTC 14.70 Decreased By ▼ -0.54 (-3.54%)
SEARL 57.55 Increased By ▲ 0.52 (0.91%)
SNGP 66.60 Increased By ▲ 0.15 (0.23%)
SSGC 10.99 Increased By ▲ 0.01 (0.09%)
TELE 8.77 Decreased By ▼ -0.03 (-0.34%)
TPLP 11.51 Decreased By ▼ -0.19 (-1.62%)
TRG 68.61 Decreased By ▼ -0.01 (-0.01%)
UNITY 23.47 Increased By ▲ 0.07 (0.3%)
WTL 1.34 Decreased By ▼ -0.04 (-2.9%)
BR100 7,394 Increased By 99.2 (1.36%)
BR30 24,121 Increased By 266.7 (1.12%)
KSE100 70,910 Increased By 619.8 (0.88%)
KSE30 23,377 Increased By 205.6 (0.89%)

From 13.25% policy rate in 2020 to all time high of 22% in 2023, the state of Pakistan’s economy still seems to find it difficult to sail its boat although considerable time has passed since the turbulent waves of Covid began to wane. Before putting forward my concern, let’s look at the rationale behind increasing policy rate.

When the government decides to increase policy rate, it intends to make borrowing more expensive which discourages borrowing and ultimately spending in economy. This pushes down demand which puts downwards pressure on prices, thus curbing overall inflation rate.

Taking a shufti at the prices as well, the inflation rate rose from 9.74 in 2020 to 37.74 in April 2023. The government took solace in policy rate to control inflation. The introductory paragraph of recent two years’ monetary policy statements cites inflationary pressures as one of the reasons behind increasing policy rate, indicating increase in policy rate as a viable solution to deal with the curse of inflation. Let’s pause it here and come back to this argument later.

In the same economy, another parallel scenario prevails. The recent budget has offered a 35% salary hike to help nation survive in the soaring inflation so that people could maintain their purchasing power. Higher salaries put an upward pressure on demand and an increased demand translates into even higher prices ultimately exacerbating inflation. To see how it works, let’s have a brief look at a few elements.

One is cost push inflation since the businesses also increase prices to compensate their cost. Another factor is feedback loop where price and wage hike reinforce each other. This happens when people predict that prices will keep on increasing due to higher wages, so keep demanding higher salaries to be able to compensate rising inflation.

Also, governments, in order to finance wage increase, prefer printing more money, thus increasing money supply and giving inflation enough room to rise.

The above two scenarios show the contradictory actions being taken by the government in addressing inflation. The contradiction arises from this fact that one policy aims to control demand while other intends to increase.

When the government continues to push the policy rate upwards while inflation persists to increase, this means that the traditional approach of dealing with inflation is not working the way it was expected and raises questions about all the factors that drive inflation and effectiveness of selected policy measures.

Two are cost pull inflation and psychology that we already explained above. Others are supply side factors, global factors, demand persistence, etc. Monetary policy may not cater for shortages of key commodities and supply side distortions and thus may not have significant effect on these. Global effects include change in global process and exchange rates. It is not a hidden fact that our population is also being fed with imported commodities.

Being unable to produce, we are importing supplies to meet the demand which is fueling inflation that is constantly eroding our foreign currency reserves. This has resulted into devaluation of rupee further, making the imports more expensive.

These are few of the reasons why policy rate hike is ineffective. Another ill of the economy is rationing. Hoarding of goods deliberately triggers the inflation through artificially distorting supply, which is eating up the economy that government fails to address and control. The pill of contractionary monetary policy will not be a solution in such scenarios.

During the course of time when monetary policy statements continued to raise the policy rate, inflation rate, ironically, also persisted to jump further without showing a slightest hint of being affected by the hike in interest rate and we wonder why this doesn’t set off alarms for the policymakers to stop injecting the economy with the same potion and find the reasons behind the ineffectiveness.

The icing on the cake is the increase in salaries which is completely opposite to what the SBP’s (State Bank of Pakistan’s) monetary policy tries to solve.

This raises another question that should we expect continued policy rate increase since we are foreseeing persistent spell of inflation caused by the government itself? We really appreciate government’s intention of being considerate towards the nation and comforting them in the tough times, but questioning the mindset of the controllers that how they are trying to lead the economy by taking poles apart decisions.

Increasing policy rate is serving as a contraindication for prescribing to control inflation, which is caused by cost pull inflation, imports and hoarding.

Our government is found to be in the complex economic condition where multiple factors are needed to be considered while formulating policies.

To our dismay, the government is stuck in this current state of crises unable to navigate a way forward and the choices made are not aligning with the broader context since without realizing the root causes of inflation, just applying the bandage of increased policy rate wont help.

We are taking contrasting actions in an attempt to support population and managing inflation. The actual challenge is to find a right mix of such policies that ensure long term stability in economy and short term needs both. This delicate balance must consider potential risks, economic indicators and their interrelations and the intensity of the policies. Without being mindful, we will never let ourselves come of out of these curses and economy will continue to fail in finding the way out of the maze unless we create the right map.

Copyright Business Recorder, 2023

Mariam Afzal

The writer is a development economist, Islamabad. She is currently working in a leading government-owned Agricultural Development Bank of Pakistan

Comments

Comments are closed.

KU Aug 31, 2023 11:49am
Good read and very well explained. Also, corruption in the revival of the economy or any plan is like a rat in your food store, without getting rid of this rat, one cannot hope to save its food.
thumb_up Recommended (0)
Ghulam Muhammad Sep 04, 2023 11:37pm
Writer has beautifully explained the route cause of failure of application of monetary policy by way of increasing policy rate to curb the inflation. There is high time to revisit the current strategy to curb inflation and instead there is need to apply mix of relevant tools.
thumb_up Recommended (0)