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Old Tuesday, April 12, 2011
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Growing worries about


By Shahid Javed Burki
Monday, 11 April, 2011


THERE appears to be a slight break in the rate of increase in the level of prices in recent weeks. But it is not significant enough for the policymakers not to worry about the prospect of increasing inflation.

A small increase in the level of prices is expected and is healthy for the economy. It leads to a better allocation of resources within the economic system. What is not healthy is a persistent increase in prices with an upward trend. This is has been the case in Pakistan and should be a matter of concern for the policymakers in Islamabad as well as those who manage the central bank.

There are several reasons for the increase in prices. These can be caused by disruptions in supplies. This is what happened during the floods of last year when the damage to the infrastructure made it difficult to transport goods from the points of production to those of every day consumption.

Supplies may also be affected if a crop that is an important source of consumption suffers from an unexpected decline in production. This could be caused by floods as hap pened last summer.

But it could also result from disease and pestilence. This occurred in the early years of the rule by General Zia ul Haq. In these supply related reasons for inflation, the country can bring in imports if it has the resources to purchase them. This is what was done by the Zia government which not only bought wheat from abroad but set up a new body for hauling it to the major centres of consumption. Thus was born the National Logistics Cell which was established by the military and managed the task of transporting more than a million tons of wheat upcountry.

The NLC went on to become not a major road haulage company. It has also become a large road construction enterprise. The Lahore ring road, for instance, is being constructed by NLC.

Inflation can also result from the stimulation of domestic demand. This normally happens when the governments run large fiscal deficits and finance them by borrowing from the central bank which in turn uses the printing press to print money. This is what is occurring at this time.

Consumer prices increased by 12 per cent in the financial year 200708, the last year of the Musharraf period, and then again by 20.8 per cent in 2008-09, the first year of the democratic government.

The level of price increase moderated in 2009-10 when it was estimated at 11.7 per cent but picked up once again in the first six months of the current financial year. There were different reasons for these price movements and it is worth recalling them in order to draw some public policy lessons from them.

The price rise in the waning days of the Musharraf period was because of the loosening of the fiscal purse strings by the government and the use of cheap money to stimulate domestic demand. This was the classic approach of a government preparing for elections.

Musharraf’s financial and political advisors thought that by creating a sense of prosperity among the people it would be able to persuade a large segment of the electorate to cast votes for the ruling party, the Pakistan Muslim League (Q). That did not happen and the opposition triumphed, using the need for the country to return to democracy as a more powerful tool than perceived economic wellbeing.

The successor government inherited a difficult economic situation, the consequence of the poor management of the economy by the previous regime. Whether it would have been to stabilise the economy is debatable; before it could settle down Pakistan was hit by one of the sharpest increases in commodity prices the world has experienced in recent years.

The international increase in prices was led by oil, an extremely important commodity for Pakistan. The price of oil climbed to unprecedented levels and Pakistan found that it was rapidly running out for foreign exchange reserves in order to meet the ever-increasing import bill. Islamabad turned to the International Monetary Fund when the fear grew that it may not be able to meet with its foreign obligations.The Fund, which had received a large infusion of finance to handle the problems faced by countries such as Pakistan, obliged by signing a very large Standby Arrangement with Islamabad. The SBA came with the usual conditions, among them the need to reduce the fiscal deficit.

This was necessary, as indicated above, to prevent the government from having the State Bank run the printing press. Some of the IMF-induced fiscal discipline helped to moderate the price situation. There was also help from the international side, as the price of oil declined almost as rapidly as it had increased.

The current inflationary situation is the result mostly of a political environment which, the rulers believe, severely limits their options. They are of the view that the reform of the tax system which is essential to place the government’s finance in order cannot be put in place without disturbing the fragile coalition that governs the country at this time.

Among the measures that need to be adopted include taxing agriculture. This is one of the largest sectors of the economy. It is scandalous that income from it is not being taxed. ZA Bhutto’s decision to tax farm incomes was annulled by Ziaul Haq.

Services are proving difficult to tax since the provinces argue that this should be their revenue to collect. The rich either manage to escape paying taxes or ensure through pressure to keep their assets outside the purview of the tax authorities. It is because of this that owner-occupied houses are not taxed, why capital gains are tax exempt, why the Musharraf administration abolished wealth tax, and why the items of consumption by the rich are kept out of tax net.

Ultimately the rich by lightening their own burden shift it to the poor. Low tax-to-GDP ratio hurt the poor in many ways. Of these two are important. The government is unable to provide them the services the poor need. This is one reason why the quality of education and health care provided to the poor by the state in Pakistan is of such poor quality.

Also, as discussed above, a cashstrapped government tends to run to the printing press to provide itself with the money it needs. This results in inflation which, in fact, is a tax on the poor. Another way of looking at rapidly increasing prices is to see it as an erosion in the incomes of the poor.

The thrust of the argument made here is that the government has many reasons for being concerned about inflation. If it persists it produces inflationary expectations which builds price rise into human behaviour. Once that occurs it is difficult to get it out of the economic system.

Also, by reducing the real incomes of the less advantageous, it causes great resentment which could lead to political explosion on the streets that is rocking the Middle East at this very moment.

By not addressing the problem of inflation by improving the tax system since such a move would not be supported by the well-to-do, the policymakers are inviting another political problem: the wrath of the poor.
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