Rising prices of wheat flour and sugar continue to make headlines. Hoarding and short supplies of sugar and hoarding and smuggling of wheat and wheat flour are often blamed for making these most essential food items dearer by the day.

According to the Pakistan Bureau of Statistics (PBS), national average prices of wheat flour and sugar have shot up 18.6 per cent and 23.5pc, respectively, on a year-on-year basis.

PBS statistics show that the price of plain bread also went up by 18.5pc and that of a one-kilogram pouch of vegetable ghee by 19.8pc over the same period. Eggs and fresh loose milk have become 35pc 8.5pc costlier, respectively. The list of essential food items registering price hikes in a year goes on and on.

The PTI government should improve coordination between fiscal and monetary authorities

But inflation is not limited to food prices. Lots of non-food items, including fuel oil, also continue to show a rising trend. Annualised national average inflation, measured by the Consumer Price Index or CPI, shot up to 10.7pc in 2019-20 from 6.8pc in 2018-19. In July, CPI inflation stood at 9.3pc — higher than 8.4pc a year ago. Inflationary pressures are stubbornly strong. Has demand for goods and services remained strong? Were the supplies constrained too much? What was actually driving inflation up last year and what is still keeping it high?

In the last fiscal year, the annual flow of currency in circulation (CiC) more than doubled to Rs1.19 trillion from Rs562 billion a year ago. If inflation is essentially a monetary phenomenon, as many economists argue, then the unusual expansion in CiC must have played a role in fuelling inflation in the last fiscal year. If CiC keeps expanding then taming inflation even during this year would be too difficult. This is not to suggest that an unusual rise in CiC alone is responsible for fuelling prices but to bring into discussion its role in influencing inflation in Pakistan.

In 2019-20, the federal government’s net borrowing from the State Bank of Pakistan (SBP) remained negative by Rs65bn. This means additional currency note printing did not affect the yearly flow of CiC in that particular year. A plausible explanation is that it was the federal government’s 2018-19 net borrowing of Rs3.16tr from the SBP that had a lagged impact on CiC in 2019-20. Since the national economy shrank by 0.4pc, this massive borrowing from the central bank was in effect additional currency note printing — a large part of money thus created remained in circulation. When CiC remains high, it tends to push up inflation and that was exactly what we saw in 2019-20.

That was why the central bank remained reluctant to go for monetary easing despite pressure from the government and businesses alike in the nine and a half months of 2019-20. It started cutting the interest rate from March 18 after Covid-19 had hit Pakistan. The SBP reduced the key policy rate by 625 basis points in the next two and a half months. With the start of this fiscal year in July, the expansion in CiC has somewhat moderated — thanks to, among others, the amnesty scheme offered by the government that has helped individuals and businesses whiten some of their ill-gotten wealth. The pace of CiC expansion is one of the few key factors that will impact the future course of inflation.

In 2019-20, high CPI inflation also reflected the lagged impact of massive 31.7pc rupee depreciation in 2018-19. The volatility in the exchange rate in 2019-20 also kept inflationary pressures up. More so, it continued feeding inflationary expectations.

In 2019-20, the rupee witnessed just 5pc depreciation after Pakistan entered the International Monetary Fund (IMF) programme and also borrowed foreign funds from friendly states and local and foreign commercial banks. So the lagged impact of the rupee depreciation in the last fiscal year should be relatively less pronounced in this fiscal year’s inflation. But if the stability in the exchange rate achieved in 2019-20 and maintained thus far in 2020-21 is shaken amidst growing concerns about Pakistan’s ability to sustain its recent gains in external account fundamentals then that too might keep inflation high.

On the fiscal side, the repeated increase in fuel oil prices and the withdrawal of energy subsidies have the potential to keep inflationary pressures intact. In one and a half months of this fiscal year, the per-litre price of petrol has already risen to Rs104 from Rs74.52 in the last week of June. The price of diesel, likewise, has gone up to Rs106.46 from Rs80.15. Such a massive increase in fuel oil prices in less than two months have flared up inflationary expectations in an already charged political environment besides leading to an immediate hike in the prices of goods and services. The most unfortunate aspect of the recent fuel oil price hike is that it has come at a time when the central bank has just finished, or seems to have finished, a gradual easing of monetary policy.

If the PTI government is really serious in kick-starting the economy, it needs to improve the fiscal-monetary coordination. Fuel oil price hikes are the most readily available tools for tax revenue generation. But their impact on businesses is just the opposite of what a relaxed monetary policy is aimed at i.e. helping industries produce more at a reduced cost to lift demand and boost economic growth.

Published in Dawn, The Business and Finance Weekly, August 17th, 2020