After a brief hiatus, inflation has resurfaced around the world. The debate on inflation management is divided: the traditional approach favors high interest rates and reduced liquidity, which can slow down economic growth.
Some believe that inflationary pressures will be temporary and will ease with economic expansion and supply chain improvements. However, recent geopolitical uncertainties such as the conflict in Ukraine have caused commodity prices to rise.
Understanding inflation
Inflation affects the lives of citizens and can limit economic growth. Demand can be caused by both pull (high demand) and supply (limited supply) factors. Therefore, inflationary pressures vary across the country, requiring appropriate policy responses.
High inflation in Pakistan:
- Weak economic base
- Global currency value increases
- Back up by the government and suppliers
- Policy incentives such as extended tax measures, including soft financing and income support programs, during the COVID-19 period
Policy prescription
In this context, the inflation targeting strategy should be carefully considered. Tightening monetary policy is not the only anti-inflation tool, because it can severely reduce output and employment. Effective governance requires monetary and fiscal policy coordination.
Although the 2022 supplementary budget aims to reduce demand, new aid packages and new funding programs should be carefully reviewed. It is very important to do a cost benefit analysis and assess the impact of inflation before implementation. Appropriate fiscal policy, among other factors, is needed to maintain the current monetary policy position with negative interest rates.
A proper calibration of policy can reduce inflation by reducing aggregate demand. Fiscal reforms are needed to ensure better value for money in public spending and increase negative government savings.
Fight food price inflation
Food price inflation directly affects people’s lives, especially in low-income countries like Pakistan. Unresolved importation is a complex problem that increases dependence on imported food and agricultural raw materials. This neglect occurs especially when food price inflation is higher than overall consumer prices.
Agricultural productivity in Pakistan is very low, with five major crops: wheat, cotton, sugar, maize and rice leading the world. A change of mind is necessary. Administrative measures to reduce prices have failed. Policy makers need to understand that government involvement in agriculture disrupts the market. Substantial reform should redefine the government’s role in commodity operations, focusing on maintaining strategic reserves, improving regulation and strengthening research.
A modest increase in research spending from 0.8% to at least 2% of GDP is required. The right incentives should be provided to align universities and research institutes with farmers to improve farmland and improve productivity. Market-oriented reforms can reduce reliance on middlemen, help price discovery, and ensure timely supply of imports and exports.
Major reform
While stimulus policies often dominate the headlines, broader reforms are needed to manage inflation and address supply-side issues. It is important to expand domestic production capacity in industry, agriculture and services. Growth above GDP can limit price increases and increase the supply of domestic goods. The main areas of change are:
- Transition to the energy sector
The transition from a state-dominated energy sector to a privatized market is essential to achieve efficiency. These include the development of new LNG terminals, North-South gas pipelines, competitive gas prices and green energy.
Energy efficiency and conservation programs, along with an improved public transportation system, can reduce dependence on imported petroleum products. This transition requires new skills, behaviors and lifestyles. Among global commodity prices, the exploration of mineral resources of Pakistan is also important.
- Agricultural productivity
Increasing agricultural productivity through research, improved cropping techniques and market reforms can have a significant impact on inflation. Incentives are also needed to encourage investment in the productive sector rather than real estate.
- Investment status
Changing the regulatory and investment climate is essential to attract domestic and foreign investment in the manufacturing sector. This will expand the economic capital and increase the productivity of workers through new tools and skills.
The proposed solution goes beyond temporary measures and emphasizes fundamental anti-inflation reforms. The focus is on reducing food inflation, which erodes the purchasing power of the poor and middle class, and affects health and education costs.
