INFLATION has varying effects on different categories of households. Rising inflation amidst lower-than-before economic growth means a fall in income for most categories of households.

In 2018-19, the economy is growing slower than it was a year ago. One can safely assume a decline in income for most household categories.

Erosion in purchasing power along with lower incomes means a double whammy for households. Remember, purchasing power is eroding not only because of inflation but also depreciation.

In spite of the ongoing interest rate hikes, it is difficult to predict how soon inflation will recede. It is also difficult to project how enormously the fight against inflation will take its toll on the economy at a time when keeping the rupee stable remains an even bigger challenge.

In the last fiscal year, inflation measured by the Consumer Price Index (CPI) stood at 3.9 per cent, with food inflation at 1.8pc and non-food inflation at 5.4pc.

But the rupee was deliberately kept overvalued during that year. It shed 15.9pc value against the dollar in the interbank market, but this quantum of depreciation was far smaller than required given that the current account deficit had shot up to $19 billion from $12.6bn a year earlier.

Higher industrial growth coupled with continued subsidies to both industrial and agriculture sectors — at the cost of expansion in the fiscal deficit — and the consequent better showing of the services sector took GDP growth to a 13-year high of 5.8pc.

The transmission of monetary tightening takes longer to tame inflation while erosion in purchasing power along with lower incomes means a double whammy for households

All this worked quite in favour of the PML-N government in the final year of its five-year tenure.

But when this fiscal year began under a caretaker government, the nation learned to its horror that the fiscal deficit had swelled to Rs2.26 trillion, or 6.6pc of GDP, from Rs1.48tr, or 4.3pc, a year earlier.

Now the challenge for the PTI government is to manage a high fiscal deficit and fix a huge current account deficit of about $19bn.

What we have seen so far — a rapid depreciation, removal of subsidies, cuts in development expenses and desperate securing of financial help from friendly countries — are responses to the above-mentioned challenge. This is what the government says and obviously it holds some truth.

However, critics insist knee-jerk responses, like an overemphasis on filling the state coffers via retrieval of plundered wealth, using the slogan of accountability to silence political opposition, giving in to the pressure of powerful lobbies in its drive for expanding the tax net, experiments in the taxation regime, making banking transactions painful for even legitimate foreign currency holders and initial dilly-delaying in consulting the IMF for a bailout, confused the private sector.

Such confusion coinciding with the rupee’s fall jolted the markets and led to stronger-than-usual inflationary expectations. This, combined with the expansion in currency outside the banking system, which remains high despite documentation drives, is also responsible for fuelling inflation and discouraging private-sector investment.

Inflation during this fiscal year has spiked for a variety of reasons including, but not limited to, a lagged effect of the last fiscal year’s depreciation, ongoing decline in the rupee’s value, higher inflationary expectations, expansion in money outside the banking system and massive note printing during the last fiscal year as well as the first five months of 2018-19.

Higher inflation remains a concern and the central bank is fighting inflationary pressures with higher interest rates.

It should not be difficult to assume how this will impact an already low level of private-sector investment in 2018-19. In 2017-18 when inflation was below 4pc, private-sector investment stood at 9.8pc of GDP while the savings of non-government sector, including the private sector and public-sector enterprises, was equal to just 7.5pc of GDP.

The interest rate tightening, which is likely to continue to keep inflation in check and meet one of the pre-conditions of a new IMF loan package, means higher financial cost for businesses and lower margins. In contrast, the contraction in demand as a result of higher interest rates will mean further erosion in businesses’ profits. One can imagine how our private sector’s savings and investment will grow in such a stifling environment.

As for the government spending, it is but obvious that in its drive to keep fiscal deficit in check, Islamabad will have to reduce both development and non-development expenses. The extent to which these expenses will be limited can be smaller if the government succeeds in boosting tax revenue, the signs for which so far are not very encouraging.

In an economy where markets are imperfect, transmission of monetary tightening takes longer to tame inflation.

Keeping these facts in mind, we cannot hope much for an immediate relief in inflation. And given the fact that the agriculture sector’s performance is projected to deteriorate during this fiscal year and energy subsidies are being withdrawn rapidly, inflation for the poor, gauged with the sensitive price index (SPI), is expected to remain a bigger worry.

Inflation measured by the wholesale price index (WPI) that takes into account ex-factory or ex-farm prices of food and non-food commodities is also rising too fast: year-on-year increase in WPI that stood at just 2.9pc in November 2017 shot up to 13.5pc in November this year.

Our key gauge of inflation — CPI — has not gone berserk. But even the CPI-based annualised inflation that stood at 4pc in November last year rose to 6.5pc in November this year.

When and how a very high increase in WPI will start impacting CPI and SPI and how this will have an overall impact on the economy are issues that analysts will watch with interest in 2019.

Published in Dawn, The Business and Finance Weekly, December 31st, 2018