Inflation will determine growth: the lesson for Zardari
According to a Business Recorder report, the Planning Commission has projected growth at 6.5 percent for the next year, while the two multilateral agencies, ie, International Monetary Fund and the World Bank have assessed it at around 3.5 percent.
The National Economic Council chaired by the Prime Minister, on the other hand, has estimated 5.8 percent GDP growth for financial year 2008-09. According to an earlier report in this newspaper, the Planning Commission projection at the NEC, was slashed due to the intervention by the State Bank Governor, Dr Shamshad Akhtar, on the ground that the Planning Commission assessment was unrealistic as it did not take into account the prevailing macroeconomic conditions.
Why are the assessments from three different sources at such a variance? The Planning Commission's optimistic assessment is based on traditional cum historical methodology. In the recent past, the base of the national income accounts was changed by the Federal Bureau of Statistics, from 1980-81 to 1999-2000 resulting in the nominal GDP increasing significantly from the year 1999-2000 onwards.
As a result, all the variables (tax to GDP, non-tax to GDP, social sector spending, developing expenditure etc) post 1999-2000 show substantive reduction. On the other hand, the revised basing provided fiscal space to the government to borrow from within and outside, in absolute terms and also show a reduction as of fiscal and current account deficits as a percentage of GDP.
Without disputing the statistics of FBS (for the real sector) the SBP's assessment appears to be based on the constraints emerging from falling reserves due to the continuous rise in trade deficit. Import bill increased 30 percent in FY08 over FY07. In this period, POL imports have gone up by 33 percent and non-oil imports are also up by 28.6 percent over and above the FY07 level.
Assuming zero growth and no change in POL imports, and incorporating crude oil at $150 per barrel, as proposed by the Economic Advisory Council to the budget makers, oil imports in FY09 would be nearly $20 billion. With exports projected at $25/26 billion for next year, policy makers would have to pursue sharper import compression. Therefore, Planning Commission's estimate of import growth has to be slashed drastically by more than half to 6.5 percent. Compression in imports is possible by raising tariff walls, as well as maintaining the 35 percent margin on import letters of credit for non-essential goods to conserve foreign exchange.
Higher cost of raw material along with electricity shortages taking a toll on manufacturing output and higher cost of inputs in agriculture such as DAP and diesel would reduce the overall growth closer to 5 percent of GDP instead of the projected 5.8 percent. Even a 5 percent level of growth would be acceptable. However, SBP would need to be given a free hand in maintaining its tight monetary stance. Islamabad, on the other hand, needs to cut back on non-productive expenditure and take effective administrative steps for tackling distribution and supply side obstacles in the food supply chain.
Planning Commission's projection of 11 percent inflation in FY09 also appears to be unrealistic. It would be closer to 14/15 percent, as estimated by SBP, due to higher cost of imported raw material and taking into account the impact of tariff rise on energy inputs, in both industrial and agriculture sectors. Further, the expected announcement of a hike in wages all around as well and a number of other populist measures expected in the budget, coupled with subsidies for wheat, fertiliser and funding of loss making PSEs such as; PIA, Railways, Wapda, KESC, etc, are the danger points which may force higher governmental borrowing.
If GDP growth is at 5 percent and inflation is at 15 percent, then SBP's traditional formula for broad money supply will be 20 percent. The increase in money supply by 20 percent will further compound inflationary pressures in the economy.
In FY08, the initial shock of food prices may have come from supply side, but excessive government borrowing from SBP definitely diminished the impact of SBP's monetary tightening. Those advocating slashing of interest rates and pumping up liquidity have conveniently forgotten that the present economic mess is primarily the result of inaction by fiscal managers. Even the monetary tightening impact got diluted due to excessive government borrowing.
Last month, the Fund and the World Bank conducted interaction with the present political set-up. Their prescription is for further monetary tightening and fast track adjustments in POL prices as well as power and gas tariffs. There is a price to pay for this prescription.
Political and social cost of overnight adjustments of POL prices, rise in power tariff coupled with slashing of subsidies are major challenges facing the government. Fund/Bank's tight demand management prescription will reduce the growth to 3.5 percent of GDP for FY09. It is therefore critical for policy makers to make the right choices in order to reduce the present exceptional rise in inflation.
The key to stop the haemorrhage in the economy is put a tightly shut lid on government borrowing from SBP in Budget FY09. This requires a cut in the non-development expenditure by at least Rs 100 billion, keeping the PSDP close to Rs 450 billion and raising resources to keep the fiscal deficit below 4.0 percent. Furthermore, we need to stimulate the textile sector to achieve scale and cost efficiency and obtain export diversification. And, above all it must reduce the imbalances to reverse the outflow of foreign exchange.
This newspaper understands the political fallout from persevering the tight demand agenda. PPP Co-Chairman Asif Ali Zardari needs to provide the political strength to the government and the central bank to cut down inflation. The longer inflation is allowed to climb, the greater will be the danger to future economic growth.
This nation between 1999 and 2002 was made to 'bite the bullet' and underwent pain to achieve macroeconomic stability. Unfortunately, the then prime minister Shaukat Aziz placed the economic reform process on the back burner after June 2006 to help elect President Musharraf and PML (Q) in the forthcoming elections.
Failure to curtail the aggregate demand resulted in power blackouts and wheat flour shortages and routed his party in the elections. There is a lesson for Zardari and the PPP to learn from this. One year of economic indiscipline washed away years of macroeconomic stability. FDI shooting up from one to eight billion dollars a year was not because of the 'shinning' stock market. It was due to macroeconomic stability and keeping the fiscal deficit on a downward path.
Business Recorder [Pakistan's First Financial Daily]
