Inflation a la Khan style!

The PML-N administration’s April 2018 budget for the current fiscal year projected a rise in inflation to 6 percent as opposed to 4.5 percent in 2017-18 reflecting external factors, particularly the rise in oil prices due to US sanctions on Iran, effective 5 November, though the grant of waivers to around 8 countries has lowered the oil price with Saudi Arabia announcing a cut in supply to keep prices stable.

Miftah Ismail, the Abbasi-led government’s finance minister by default (Ishaq Dar having first gone into depression after the Panama papers verdict that led to a case being filed against him for possessing wealth beyond known means of income and later his ignominious departure from the country), stated mid April 2018 that during the five years of the party’s administration inflation had been brought down from 11 to under 4 percent (though his budget document showed a rate of 4.5 percent). The why is fairly obvious: the international price of oil plummeted during the PML-N tenure in marked contrast to the PPP-led coalition government’s tenure when oil price registered a peak of over 140 dollars per barrel. By early 2016 the price of crude was more than 70 percent lower than in 2014 accounting for a windfall ‘fiscal space creation’ for the Dar led finance ministry. Unfortunately he frittered this space away by: (i) massively raising current expenditure – from the budgeted 2.6 trillion rupees projected in the 2012-13 budget to 3.7 trillion rupees budgeted for 2016-17 though revised estimates placed the figure at 3.9 trillion rupees; and 4.29 trillion rupees in the revised estimates of 2017-18. Ismail projected a further rise in current expenditure to 4.78 trillion rupees in the current year. Running of civilian government, a major component of current expenditure rose from 239,954 million rupees in the budget 2012-13 to 463,371 million rupees for the current year – a rise of 93 percent in just five years. This increase contributes significantly to the current economic impasse; (ii) met the rise in current expenditure through borrowing. Dar years account for a rise in annual markup on domestic and foreign debt from 925,775 million rupees in 2012-13 budget to 1,620,230 million rupees in 2018-19 April budget; and (iii) in an attempt to reduce the budget deficit Dar held the economy hostage to low growth through slashing public sector development programme instead of current expenditure. Pakistan registered one of the lowest growth rates in the region barring the civil war-torn Afghanistan during the PML-N tenure. Dar more focused on showing a better performance compared to the Zardari government years instead of regional economies, which reflected different economic factors, dishonestly (a) doctored the growth rate downward for 2010-11 when he took over the finance portfolio so he could show the highest growth rate for 2013-14 since 2008, and (b) repeatedly doctored the GDP growth rate upward during his entire tenure which was challenged by independent economists.

Two decisions that can, at best, be categorized as shirking responsibility or passing on the buck and, at worst, poor governance were taken by Miftah Ismail and approved by the Shahid Khaqan Abbasi-led cabinet that no doubt artificially stayed the inflation rate: (i) the decision to defer the increase in oil prices as recommended by Oil and Gas Regulatory Authority on the very last day of the Abbasi-administration’s tenure – 31 May – a decision that is required to be taken by a government on the last day of each month for effective application from the first of the month. The reasons for the deferral were clearly political and violated the concept of good governance; and subsidies including keeping gas rates constant, for ostensibly ensuring that the public did not suffer from a price hike led to (ii) the decision to fund the rise of the deficit through borrowing at whatever cost, including from the domestic and external commercial banking sector – a highly inflationary policy. Sadly, the Khan-led administration has already borrowed 2 trillion rupees from the State Bank of Pakistan, a highly inflationary policy.

Economic compulsions necessitated that the incumbent government take three decisions immediately though it has had to pay a high political cost for them: raise fuel, electricity tariffs and gas rates. With the rise in fuel costs, a rise in the cost of perishables was a certainty as transport costs rise. With a rise in electricity and gas rates costs of inputs of most manufacturing units rise that would have a negative impact on domestic prices as well as exports. In addition, the fuel sector is inhibited by a circular debt of over 1.3 trillion rupees and until and unless an attempt is made to plug this massive black hole, no government will be able to move forward. True, previous administrations on an International Monetary Fund (IMF) programme, also favoured raising fuel and utility tariffs instead of ushering good governance yet the state of the economy today is much worse than what was inherited by the Zardari-led or the Nawaz Sharif-led government on two counts: (i) declining exports, a burgeoning current account deficit; and (ii) an unprecedented rise in external indebtedness with the previous government after the completion of the IMF programme and the abandonment of all prudent sector reforms, particularly in the power and tax sectors.

Is there an out for the Khan administration whereby it may be able to minimize the inflationary pressures in the country? Three actions need to be taken on an emergent basis. First, there is an urgent need to reduce current as opposed to development expenditure. The two major components of current expenditure that need to be revised downward are (i) civil administration expenses that as mentioned above rose dramatically during the past five years and one would hope that the government, after consultation/negotiation with civil service representatives, is able to freeze this item for a year or two as an austerity measure; and (ii) engaging with the military to voluntarily reduce its budgeted outlay again for the short-term. The establishment is extending unprecedented support to the Khan administration and the prime minister would be well advised to broach the subject with the chief of army staff.

Secondly, to ensure that the poor and vulnerable remain unaffected while at the same time, PTI’s manifesto promises are met the Khan administration must strengthen the Benazir Income Support Programme (BISP) that is targeted towards the vulnerable/poor and whose beneficiary list has been vetted by multilaterals. All government social sector reforms including health, education, housing, must be channeled through BISP which would ensure that support is targeted to those who need it most.

And finally, the government has taken measures to increase regulatory duties on unnecessary imports instead of banning these imports however without better policing along our long porous borders to curtail smuggling, these products would almost certainly find their way into our markets and the windfall profits of the smugglers would fuel, not reduce, inflationary pressures.

Finance Minister Umar is under the misapprehension that perfect competition conditions prevail in Pakistani markets and demand and supply dictates price. Unfortunately, in Pakistan market imperfections predominate with powerful cartels, massive smuggling, tax evasion/avoidance and outright theft of utilities. In short, he would be well advised to deal with market imperfections and strengthen those institutions that deal with these imperfections for example the Competition Commission of Pakistan rather than explain to parliament how price is set in a perfect competition situation, which really does not prevail in the country.