Inflation is down!

Economists and analysts alike are challenging government data with respect to nearly all macroeconomic indicators barring the one on inflation. And there is good news on that front: inflation is down considerably in recent months.
How does the State Bank of Pakistan (SBP), with a major responsibility for checking inflation, explain the decline in inflation? The much delayed SBP report 2014-15, released inexplicably six months into the current year making it all but irrelevant, maintains that a "steep fall in international oil prices, robust growth in worker remittances, and strong CSF (Coalition Support Fund) inflows, helped reduce current account deficit to 1 percent of Gross Domestic Product in Fiscal Year 2015. This along with successful issuance of Sukuk in the international market, higher net disbursements from the IMF, and continued foreign exchange purchases from the market pushed up SBP's liquid foreign exchange reserves to more than 3 months of the country's import bill. This stability in the PKR and the government decision to pass on the benefit of a fall in international oil prices to domestic consumers, helped contain inflation and improve the inflationary outlook." Can this logic be challenged? Or more particularly do any of these claims reflect positivism with respect to economic policies than is in fact the case.
Last things first: the SBP report claims that its liquid foreign exchange reserves are more than 3 months of the import bill, and attributes this to actions by the government (Finance Ministry) and its own: (i) successful issuance of sukuk, a decision by the Finance Ministry. Yes Dar succeeded in issuance of these sukuk bonds but the agreed profit rate was a high 6.5 percent, at least one percentage point over the rate that heavily debt ridden Greece paid on its bonds; (ii) higher net disbursements from the IMF, again a Finance Ministry decision to go on a Fund programme. Unfortunately, however, with repayment of the ongoing IMF's 6.64 billion dollar Extended Fund Facility becoming due by end of next calendar year, the expiry of the rescheduled Paris club as well as the 5-year Eurobonds maturing by the end of next calendar year the debt repayment burden would be very high leading to a net outflow with negative repercussions on our current account deficit around general election time; (iii) Coalition Support Fund which is released by the US for fighting the war on terror and which began during the Musharraf era but are expected to dry up in months to come; and the only SBP action mentioned in the report namely (iv) continued foreign exchange purchases from the market which raised foreign reserves and artificially propped up the rupee with a consequent negative impact on raising the budgeted debt servicing.
Three other factors, all external, contributed to lower inflation as per the SBP report. Firstly, a fall in international oil prices; in 2008 the international price of oil reached a historic high - at 140 dollars to a barrel accounting for petroleum and products contributing to a little over 30 percent of our total import bill. By January 2015 this item accounted for 25.7 percent of our total import bill and in October 24.5 percent of our total bill - a decline reflecting a steady decline in the price of oil in the international market. The Consumer Price Index (CPI) allocates 7.32 percent to transport and communication and 29.41 percent to housing, water, electricity, gas and other fuels. The SBP report, reflecting a political bias instead of engaging in a more academic debate, noted that the decision of the government to pass on the decline in oil prices helped contain inflation. While this is true yet the report fails to take note of the (i) heavy taxes imposed on this product by the government with one estimate revealing that 44 percent of all sales tax collections are from petroleum products; and (ii) taxes on fuel are a percentage of the imported price of the commodity and hence any decline in oil prices has led to a commensurate increase in taxes to keep the budgeted revenue from this critical and easy to collect source unchanged. This explains why the tax on furnace oil is over 45 percent and no doubt accounts for the failure of our exporters to compete with regional countries where taxes are not that high on petroleum products, a key input for most of the productive sectors.
Secondly, a much larger contributor to the low rate of inflation in Pakistan is the decline in commodity prices in the international market (wheat our staple, edible oil). Food and non-alcoholic beverages account for 34.84 percent in the CPI calculation and include both domestic and imported items. Be that as it may, the decision of Ishaq Dar to levy a 3 percent across the board customs duty on all imports no doubt has played a part in neutralising the positive impact of the decline in commodity prices. However, with a decline in the international commodity prices it is little wonder that in spite of higher taxes the rate of inflation remains low.
Remittances are another source of foreign exchange that has been contributing substantially to our economic health. However, the remittances of regional countries including Indian and Bangladesh, have tapered off in recent months reflecting a world-wide trend and Pakistan is projected to follow suit.
Finance Ministry's contribution to a low rate of inflation is mainly through contractionary fiscal policies (higher taxes to mop up excess liquidity and sale of bonds) but without a rise in expenditure. Unfortunately, there has been no attempt to lower the rise in current expenditure, in spite of protestations to the contrary. Current expenditure in 2012-13 was budgeted at 2.6 trillion rupees and 3.48 trillion rupees in the current year or a rise of 25 percent - with general public service outlay accounting for the bulk of this rise - from 1.876 trillion rupees in the last year of the PPP-led coalition government to 2.44 trillion rupees projected in the current year.
The budget deficit has, however, been contained though not by as much as claimed by Dar with economists maintaining that the projected deficit would be at least 1 to 2 percentage points higher than budgeted. Be that as it may, the decline in the deficit, as in the past, has been paid by development as opposed to current expenditure and reports indicate that Dar has already agreed with the Fund to slash development expenditure by 25 percent in the current year with the objective of keeping the deficit low. This would have positive implications on the rate of inflation but at the cost of growth and employment opportunities.