The inflation print for March clocked in at 20.7 per cent year-on-year, the lowest level in two years. However, it still remains considerably elevated over the long-term average. Over the last two years, inflation above 20pc on a year-on-year basis has led to significant demand destruction, as real incomes and purchasing power continue to decline.

However, despite demand destruction at a household level, the government’s insatiable appetite for plugging its fiscal deficits through more debt continues to fuel more inflation.

The government’s inability to initiate reforms that rationalise expenditures, as well as the inability to expand the tax net to increase tax revenues at a pace faster than inflation, continues to keep the fiscal deficit elevated. An elevated fiscal deficit eventually translates into higher inflation, as more money is printed to buy fewer goods available in the economy.

The destruction of demand has been real. The Large Scale Manufacturing index remains lower than its peak of March 2022, implying that over the last two years, manufacturing has remained well below earlier peaks and even below optimal levels. An increase in electricity prices continues to contract per capita electricity consumption as industries increasingly move off the grid while households are severely constrained by their budgets.

The chatter of a reduction in interest rates should not be heeded till the time the US Federal Reserve also starts easing rates

The CreditBook MSME Index essentially tracks the daily transactions of more than 30,000 Micro and Small Enterprises. A review of transactional data during the month of Ramazan suggests that there has been a drop in real spending (adjusted for inflation) by around 2pc.

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This includes the impact of any shopping that takes place for Eid festivities. A lack of economic activity has translated into sub-par growth, expected to remain less than 1.5pc for the year, much lower than the expected population growth rate.

On a forward-looking basis, the country is still not out of the woods. There has been an upsurge in commodity prices globally, with the price of crude oil increasing by 12pc over the last one month. Similarly, the price of palm oil has increased by 8pc during the last one month as well.

An upswing in international commodity prices generally has a contractionary impact on Pakistan’s economy, given its high dependence on imports of crude oil and palm oil and perpetually constrained foreign currency reserves. Any sustained increase in commodity prices over the next few months can potentially trigger another round of inflation, leading to another spiral of price increases.

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The only way to snap out of such a conundrum is through undertaking structural reforms in the economy, that either reduces consumption of oil in the economy through a massive roll-out of public transport, or through accelerating export earnings. The absence of a will to undertake such reforms would ensure that the country remains exposed to bouts of inflation driven by supply-side pressures, followed by knee-jerk reactions that subsidise demand when prices increase, further fueling more inflation.

A storm is brewing, and our policymakers remain aloof. Over the last year, the rupee has continued to appreciate against the dollar, making our exports less competitive and imports relatively cheaper. An obsession for maintaining an overvalued currency has wreaked havoc on the economy for over two decades.

The same mistakes are being repeated as the currency is gradually allowed to move to an overvalued state. Since March 2023, the rupee has appreciated more than 15pc, as measured through the Real Effective Exchange Rate.

An overvalued currency will remain susceptible to external shocks, particularly in a scenario where commodity prices are increasing. Any surge in price-driven growth of imports would lead to greater demand for foreign currency, resulting in the rupee’s depreciation, which may lead to another round of inflation.

Another factor that may compound problems and lead to the depreciation of the rupee, triggering another round of inflation, is the repayment of foreign currency debt due during the next few quarters. It is estimated that more than $1.6 billion of foreign currency debt needs to be repaid for debt taken up by power plants established during the last seven years.

Additionally, $1bn of repayment must be made on the maturity of the Eurobond, while other bilateral debt must either be repaid or rolled over. Impending foreign currency requirements to settle debt will continue to exert pressure on foreign currency reserves, making it increasingly difficult to maintain an arbitrarily overvalued exchange rate.

In such a scenario, the near-term risks to inflation remain high. A sustained surge in commodity prices can lead to a series of events that can fuel another round of inflation. Households continue to struggle with contraction in real incomes and purchasing power. Another round of inflation will further squeeze any limited purchasing power while unravelling any stabilisation measures that may have been put in place.

The chatter of a reduction in interest rates should not be heeded till the time the US Federal Reserve also starts easing rates. Any premature reduction in rates will have an inadvertent effect on the value of rupee, which is already on shaky grounds.

A forward-looking approach needs to be taken to brace for the impact of any sustained increase in commodity prices, whether through targeted cash transfers or product substitution. All efforts must be made to avoid rolling out blanket subsidies, as has been time and again over the last many decades.

Reverting back to a long-term inflation target of 5 to 7pc will remain challenging in the absence of fiscal discipline at the sovereign level. Until such discipline is attained, the country will continue to struggle with double-digit inflation while being exposed to the cyclicality of commodity price shocks.

The writer is an independent macroeconomist and energy analyst

Published in Dawn, The Business and Finance Weekly, April 15th, 2024