Annual inflation measured by the Sensitive Price Index (SPI) shot up to 15.01 per cent in the week ending on July 4. This was the sharpest annual increase in 10 weeks in a row.

Earlier, annualised inflation measured by the Wholesale Price Index (WPI) soared to 12.7pc in June.

The most widely used measure of inflation, Consumer Price Index (CPI), recorded an 8.9pc increase last month. So inflationary pressures exist. Since WPI inflation does affect the other two indices of inflation with a time lag, inflationary pressures will likely become intense in coming months, more so because of a sharp increase in gas prices from July 1.

In this backdrop, the continuation of monetary tightening makes sense. The State Bank of Pakistan (SBP) increased its policy rate by no less than 625 basis points within a year, taking it to an eight-year high of 13.25pc on July 17 from 7.5pc on July 16, 2018. But such a massive increase in interest rates has upset businesses and industries.

The rupee has lost 24.55pc value within a year, coming down to 160.03 on July 18 from 128.48 on July 19 last year. Unwieldy implementation of the documentation drive along with stricter tax measures and political uncertainty in the country continue to choke the flow of industrial and business activities.

Costly bank finance may depress credit demand of private-sector businesses and result in further contraction in bank lending

In Pakistan, we use large-scale manufacturing (LSM) as a proxy for production index. But LSM is a component, albeit the largest one, of the total industrial output. So there is a need for developing an industrial production index (IPI) to better understand the trends in industrial production.

Two central bankers, Muhammad Ejaz and Javed Iqbal, have developed a model of IPI and presented it in the form of a working paper titled, “Estimation and Forecasting of Industrial Production Index”. But unless authorities finally adopt this model or develop another IPI, LSM data will continue to remain our primary source for tracking trends in the industrial output.

In the first 10 months of 2018-19, the LSM output shrank 3.5pc as economic growth slipped to 3.3pc from 5.2pc a year earlier. Monetary tightening throughout the last fiscal year was one of the factors responsible for this. Now, as 2019-20 has begun with a full percentage-point increase in the central bank’s key interest rate, one can imagine how it will impact the LSM output during this year.

The SBP has projected average CPI inflation of 11-12pc for this fiscal year, up from 7.34pc in the last year. In 2018-19, inflation hurt LSM as did the interest rate hike. In 2019-20, a higher inflation — and further interest rate tightening to contain it — will affect the industrial output.

In the last fiscal year, the fall in the rupee’s value affected the working of industries by making imported raw materials pricier. In 2019-20, a further fall will continue to affect it negatively. The rupee will remain under pressure because external-sector imbalances persist — though they are not as threatening as before — and also because the SBP is committed to pursuing market-determined flexible exchange rates under the $6bn loan package from the International Monetary Fund (IMF). So 2019-20 looks quite challenging for businesses and industries.

Industry representatives say the requirement of seeking CNIC copies of the buyers of industrial goods and the increase in the rate of sales tax on locally produced items are the two most disturbing elements of fresh fiscal measures. A further contraction in the LSM output is almost a certainty.

Small-scale businesses and industries that feed and thrive on LSM growth are already in problem. Higher inflation, an unprecedented increase in energy prices and the rupee’s depreciation are haunting them. They have been protesting for days and have even resorted to shutter-down strikes, but to no avail. At the root of all their woes lie the documentation drive and the urgent need for the government to meet an ambitious tax collection target of Rs5.5 trillion. So the government is in no mood to listen to them because it has taken most fiscal measures on the insistence of the IMF.

The Fund has lent $6bn to us under lots of conditions. Ignoring them is just not possible. Monetary tightening, too, is part of these conditions, though it will be naïve to say keeping interest rates stable under immense inflationary pressures could be an option.

Fiscal and current account deficits peaked in 2017-18 and 2018-19, necessitating tough responses from both the government and the SBP in 2018-19. The current account deficit narrowed during the last fiscal year and the fiscal deficit is expected to shrink now — but not before inflicting pains to the population at large, business and industry.

Politics also counts. The government and opposition parties are in confrontation mode. Under the sharp axe of accountability, the opposition is struggling to build a pro-people narrative and is putting up pressure on the government to seek relief for ordinary Pakistanis.

The government is fixated on exposing “the thieves and thugs of the previous political setups” instead of mitigating harsh effects of its economic policies on the poor populace.

How the political dust settles may help determine when the government will focus its energy on tackling joblessness and inflation. Settling of political dust may also help determine how soon the country begins to attract foreign investment instead of foreign exchange largesse from friendly countries and loans from international financial institutions. Inflows of foreign investment have already halved and exports have declined. Home remittances alone continue to grow.

After the latest monetary tightening, the benchmark Karachi Interbank Offered Rate (Kibor) of all tenors has gone up. That means further increase in the banks’ effective lending rates for their clients. One-year Kibor now stands above 14pc. Add another 2-6pc to it and you get 16-20pc effective lending rates for customers — with the lowest applicable to prime borrowers and the highest to a vast majority of bank loan seekers.

So costly bank finance may depress credit demand of private-sector businesses and result in a further contraction in lending. Provisional data shows that the lending to private-sector businesses slumped to Rs588bn in 2018-19 from Rs658bn in 2017-18. A higher cost of finance was one big reason for this.

Published in Dawn, The Business and Finance Weekly, July 22nd, 2019