Double-digit inflation has become a norm over the last 10-12 years. By now, people’s inflationary expectations have hardened and they believe that prices will continue to rise at a fast pace, which in itself fuels inflation. The high rate of inflation over a long period of time has had some serious economic, social and political consequences.

First, inflation implicitly taxes savers and subsidises borrowers. The majority of financial savers are relatively low-income people trying to save for a rainy day or old age. On the other hand, large borrowers are relatively rich people who run businesses, trade and industry. Large borrowers have also developed their lobbying muscle, which they have used effectively to influence every government and the State Bank of Pakistan to keep the nominal interest rates low under the false pretext of promoting trade and investment.

As a result, real rate of return on financial saving has mostly remained in the negative territory, thereby becoming a source of transferring income from the poor to the rich.

Second, in an inflationary environment, increase in wages has tended to lag behind prices while hidden and declared profits rose sharply. This mechanism has led to the real income of the poor wage earners and other fixed income classes falling while the profits of landlords, big business houses and industrialists rise. The process has been instrumental in increasing the concentration of income and wealth.

Third, the rich have the financial ability to hedge against inflation by investing in real estate, commodities and stocks while the poor struggle to make their both ends meet. The booming real-estate market and rising stock prices are generated by high inflation and facilitated by rising income inequality.

Fourth, rising prices created opportunities for hoarding, smuggling and black marketing. The relatively influential and politically well-connected class has taken advantage of this opportunity. It has created a large ‘rentier’ class that operates in the underground economy amassing wealth without paying any taxes or facing any accountability. Given the increasing unemployment in the country, they also have been able to hire unemployed youth at low wages to engage in illegal and violent activities promoting lawlessness and terror in the society.

Fifth, the absentee landlords and the new urban rich have joined hands to take over the political system and governance enabling them to formulate economic policies that benefit them. In setting economic policies, they are not bothered about inflation and what it does to the poor as long as opportunities are created for themselves to get rich quick. Simultaneously, they have blocked any effort to develop an equitable, broad-based and revenue productive taxation system and have succeeded in paying virtually no direct taxes. Indirect taxes – passed into prices and paid mostly by the poor – have become the main source of revenue.

While prices have been skyrocketing due to economic policies that are designed to protect the economic interests of the rich, the government of the rich, by the rich and for the rich has been engaged in propaganda that inflation is not a home-grown and policy-induced phenomenon but driven by natural, external or unforeseen factors beyond its control. Nothing could be farther from the truth. It is important to correct this wrong perception and identify the real causes of high inflation.

First, natural disasters, world prices or lack of resources cannot be blamed for prolonged inflation. These are excuses used to cover up wrong economic policy choices made by those who rule the country. There are developing countries that have faced worse natural disasters than Pakistan and their economies are doing better and experiencing low inflation. There are countries that are more dependent on imports but still had a lower rate of inflation than Pakistan even in periods of high international commodity prices. There are other countries that have much less natural resources than Pakistan and the majority of their population enjoys better living standards and relatively stable prices.

Second, some blame depreciation of the nominal exchange rate for high inflation in Pakistan. They fail to understand that exchange rate depreciation is not the cause but the consequence of high inflation. As domestic inflation in Pakistan is way above that in its trading partners, the nominal exchange rate has to depreciate to compensate for the inflation differential if exports are to be kept going. It is true that in the secondary round depreciation of the nominal exchange rate leads to higher rupee prices of imports and to that extent feeds inflation. But the cycle begins from domestic high inflation to depreciation of the nominal exchange rate to higher import prices to inflation and not the other way around.

Third, there is a group of people that blames the country’s need for heavy oil import as the main factor for inflation in the context of rising world oil prices. This is a fallacious argument because a lot of countries are heavily dependent on oil imports and have still been able to keep inflation much lower than in Pakistan. Moreover, the country’s heavy dependence on imported oil reflects poor economic planning.

No government paid much attention to exploration of mineral resources even when a large part of the country is rich with mineral resources. Poor economic planning has also been responsible for the severe shortage of electricity and gas that has adversely affected productive activities and added to price pressures.

Fourth, the government makes the case that there is a wide gap between the cost of electricity and the price being paid by the consumer and that it involves a huge subsidy to the consumer. It argues further that utility prices have to be increased to reduce and ultimately eliminate this subsidy.

Unfortunately, the government has been addressing the problem from the wrong side. The problem is that the private electric supply companies are selling electricity to the government at high prices to cover their inefficient production, waste and high profit margins allowed under the agreements approved by the government involving kickbacks. Additionally, collusion between corrupt government officials and electricity thieves creates about 35-40 percent loss at the distribution stage. Honest consumers are made to bear the burden of high profit margins of the producers and theft in the distribution stage. Thus, in reality it is a subsidy given to the produces and thieves by taxing the helpless consumers.

If any culprits were to be identified for the high rate of inflation it would be the Ministry of Finance and the SBP. The Ministry of Finance is committed to follow ‘prudent and transparent public financial management’ and the SBP is required to pursue an effective monetary policy to secure ‘monetary stability and fuller utilisation of the country’s productive resources’. Not only do they violate their mandate, they also make an effort to mislead the people about the real causes of inflation – fiscal mismanagement by the government and an imprudent monetary policy conducted by the SBP.

The federal and provincial governments have been living beyond their means. Their combined budget deficit has been large and rising over the years. That deficit has been financed by external and internal borrowings, which are inflationary in their impact. Of late, and with the drying up of foreign budgetary support, the deficit has been financed by large-scale printing of notes by the SBP and credit from the commercial banks.

The SBP was given statutory autonomy in 1997 to keep monetary expansion within safe limits so that inflation remains under control. For this purpose, it was given legal authority to keep in check excessive borrowing from the banking system by any and all governments and public-sector enterprises. However, the SBP governors and board of directors became willing partners to inflation by accommodating excessive government demand for note printing and bank credit which have led to money creation way above the safe limits dictated by considerations of inflation control.

The writer is a former governor of the State Bank of Pakistan.

Email: doctoryaqub@hotmail.com
Dr Muhammad Yaqub
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