International commodity prices, the floods of 2010 and to some extent public procurement of staple grains placing restrictions on the private sector are among the main factors responsible for 14 percent inflation in Pakistan, the highest in the region.
World Bank report titled "South Asia Economic Focus - A Review of Economic Developments in South Asian Countries - Food Inflation," says that Pakistan not only imported higher inflation from international commodity prices, but macroeconomic imbalances and the floods of 2010 contributed domestically to price increase. Inflation, which hovered around 25 percent from mid-2008 to early 2009, came down somewhat at the end of 2009, but is now again around 14 percent, the highest in the region.
According to the report, in India and to a lesser degree in Pakistan, large-scale public procurement hampers the private sector not only by pre-emption, but also by taxes and rules for moving grains across state borders, and caps on storage of grains are designed to facilitate public procurement.
Demand for food is undergoing structural shifts as incomes rise. Growth in consumption of pulses, fruits, meat, eggs, and dairy items is more than double the consumption growth in cereals. Inflation in these items has been higher than cereals. Public intervention in agricultural marketing in India and Pakistan has high fiscal costs and narrowly supports cereal production, while high food inflation and continuing high rates of food insecurity is linked to inadequate supply response in non-cereal food products. Input subsidies, on the other hand, contribute to the overuse of water resources, high losses of electricity utilities, and deteriorating soil conditions because of skewed application of fertiliser.
The report reveals that the largest safety net interventions in the region-India's and Pakistan's public distribution systems for staple foods-are characterised by high leakages and therefore costs, while errors of exclusion are actually larger than the reverse; that is, large numbers of the deserving poor are not covered. These food-based safety net interventions spill over into agricultural policies, which lower the agricultural supply response to rising non-cereal price.
The report says that Pakistani governments regarding the interpretation of the Afghanistan-Pakistan Transit Trade Agreement (APTTA) have resulted in a postponement of its implementation. The areas of contention relate to bank guarantees, international requirements for sealed trucks, biometrics systems and the installation of tracking systems. Meanwhile, thousands of containers bound for Afghanistan are stranded at Pakistani ports. Iran blocked fuel supplies to Afghanistan in December 2010. It is estimated that 30-40 percent of Afghanistan's fuel is imported from Iran. The blockade halted 2,500 trucks and led to a 70 percent increase in fuel prices in January 2011. The ban was lifted in early February, but the government has since tried to source fuel from other countries. Price increases in transportation and fuels were 12.2 percent and the surge in inflation after January 2011 resulted from supply shortages mainly in food items after the devastating floods of 2010, a widening fiscal stance partly because of a 50 percent wage hike for civil servants, financing of the fiscal deficit through magnetisation, but also from otherwise welcome adjustments to unsustainable structural policies: an upward revision in electricity tariffs by 17 percent, and an end to interventions by the State Bank of Pakistan in the foreign exchange market to finance oil imports, resulted in some rupee depreciation. However, the rupee has rebounded somewhat in recent months.
The report says that only Pakistan has a formula-based price adjustment mechanism for both diesel and gasoline. Governments in the region are keeping electricity prices artificially low to the agricultural sector and, therefore, electricity prices do not play a major role in food prices. In India, many farmers receive free, unmetered electricity.
Pakistan faced higher wheat prices given the crop damage from the flooding of August-September 2010. This led to a jump in food inflation to 21.2 percent in September 2010, from 12.8 percent in July 2010 (y-o-y). The impact of higher wheat prices has been particularly large since wheat is the main staple grain.
According to the South Asia Economic Focus, for instance, in January, the Pakistan government increased fuel prices, decreased them a few days later and increased them yet again in early March, before halving them once again. . In Bangladesh and Pakistan, real interest rates were negative throughout 2010. During 2010, the authorities began tightening monetary policy. Broad money supply has been climbing between 2009 and 2010 in Bangladesh, Pakistan and Sri Lanka, growing at 22.2 percent, 14.9 percent and 18 percent at the end of 2010, respectively.
India and Pakistan maintain heavy government control over the marketing of wheat and India also on rice, the other countries have liberalised their agricultural sectors to a much larger extent. The Indian and Pakistani systems reduce the ability of the private sector to manage temporary, geographically limited supply disruptions. They are partly responsible for high food inflation over the short-term. On a more structural level, they distort agricultural incentives, and have high fiscal costs. They are maintained by the two governments' reliance on large-scale distribution of subsidised food items as crucial safety net measure.
The report reveals that the governments in the region are active in the agricultural sectors by providing public investments in infrastructure and research, and various input subsidies. Only in India and Pakistan, however, do governments play an intricate part in the marketing of food grains and impose strong restrictions on private-sector storage and trading.
The government employs a system similar to India's for public procurement, storage, and subsidised distribution of wheat only. Provincial Food Departments (PFDs) and the Pakistan Agricultural Storage and Supply Corporation (Passco) are responsible for implementing the procurement targets set at the federal level. Public procurement absorbs 15-40 percent of total production of wheat. About 95 percent of procurement by PFDs is undertaken in Punjab province.
The report warns that a water crisis may be looming in a number of districts in India and Pakistan, which have seen a rapid decline in groundwater levels. The access to water and water-use efficiency are some of the most pressing challenges Pakistani agriculture is facing. Some studies show an intricate, well entrenched system of "facilitation payments" made by farmers to increase access to canal irrigation water in the absence of official water pricing.
The report highlights that India's and Pakistan's public distribution systems for staple foods-are characterised by high leakages and therefore costs, while errors of exclusion are actually larger than the reverse, ie a large number of the deserving poor is not covered.
The number of poor increased by 1.4 percentage points in South Asian countries (Figure 4.1). In India and Nepal, the increase in the poverty headcount is less than the median while Bangladesh and Pakistan are above, with Sri Lanka at the median. For the impact on the poverty gap, in Nepal, Pakistan and Sri Lanka, the increase in the poverty gap is less than the median while the opposite is true for Bangladesh and India. except for Nepal, the net change in the poverty headcount is greater than the impact on the poverty gap. Pakistan experiences the highest net percentage increase in the poverty headcount whereas Bangladesh experiences the highest percentage increase in the poverty gap due to the food price increase. Nepal faces the least net change in both poverty headcount and gap among the South Asian countries. In Pakistan, there is no decline in poverty, the report shows.
Wheat subsidy is incurred at both federal and provincial level. At the federal level, the government absorbs the cost differential between the domestic support and sales price, and extends budgetary support to the Trading Corporation of Pakistan (TCP) and Passco for losses incurred in their wheat trading operations.
At the provincial level, wheat subsidies are incurred to meet the shortfall that occurs in the transaction of wheat by the Provincial Food Departments (PFDs), particularly incidental charges being borne by the provinces, and direct subsidies to the consumer via various schemes (eg, Ramzan package or Sasti Roti). To the extent comparisons are possible, the costs incurred by Passco and PFDs are significantly higher than those of private traders, indicating inefficiencies in handling wheat.
The system of government intervention is inefficient in the sense that producer surplus losses and budgetary costs from subsidies are significantly higher than gains for consumers. A recent partial equilibrium analysis of costs and benefits of the government's wheat policy concluded that the millers absorb most of the benefits from government subsidies, while consumers benefit at the expense of farmers. The report says that lower farm-gate prices lead to lower production of wheat, as shown by another recent study which uses a computable general equilibrium model to simulate the effects of a removal of producer taxes and consumer subsidies.
The report discloses that the removal of the distortions in wheat prices would be welfare-improving across all household groups. Income effects would dominate price effects; ie, income from increases in factor prices would outweigh welfare losses from higher prices of wheat. Higher prices of wheat from a removal of subsidies would be mitigated by increasing production.
The introduction of this national safety net has led Pakistan to more than double its SSN spending-to-GDP ratio from 0.4 percent to nearly 1 percent. The volatile security situation still presents a challenge for program implementation in parts of Pakistan. Increasing the role of the private sector in food grain marketing in India and Pakistan requires delinking of safety nets from direct public procurement of wheat and rice from farmers.
The report shows that wheat production for fiscal 2011 is projected to be 23.9 million tons, about the same as in 2010. However, due to an estimated increase in consumption of 1 million tons, ending stocks are likely to be lower; nevertheless, at 9 million tons they are at the level envisaged for the strategic reserve, and the government has lifted the ban on exports.
Despite a sharp decline in rice production resulting from flood damage to 34 percent of the growing area, Pakistan is expected to have an exportable surplus of 1.5-2.0 million tons, from production of 5 million Pakistan experiences the highest net percentage increase in the poverty headcount whereas Bangladesh experiences the highest percentage increase in the poverty gap due to the food price increase.