Zero inflation should be our target
By: Tarique Khan Javed
President, Overseas Pakistani Investors Forum.
                           Dated: 8 May 2009

A barbaric mood of taxing the poorest:
          Since 1990, inflation targeting is being practiced by many countries of the world to contain inflation at certain level over a period of time. In the case of Pakistan, Nawaz Sharif Government was happy with 12% inflation. Musharraf’s target was 4% up to 2004. Then it was revised up at the recommendation of his Economic advisors and by 2005 inflation up to 12% was justified as being not harmful rather good for growth. This was an unfortunate reversal of policy which ultimately costed Musharraf’s government. The woolly thinking led to Food inflation reaching up to 35% by Aug 2008. The woolly thinking also insisted on not devaluing Pak Rupee against USD pegged at 62 in 2004, while the inflation was devaluing Rupees internally. This led to increasing trade deficit and almost default situation by Sep 2008, when IMF programme became inevitable.

High inflation combined with fixed FX rate was a stupid and irrational policy. Which destroyed local industry and exports, while providing a killing field to importers and countries like China? Who flooded our market at the cost of our own manufacturers?

Thanks to IMF, now the CPI inflation has come down to 19.1 by March 09 and expected to come down to 14% by June 2009 and to 10% by June 2010. Now the question is Will we be happy with 10% inflation or 5% or 0% inflation? We, as a nation must debate the issue in depth and come to conclusion, whether inflation is good or bad? Is mild inflation OK? Is 12% inflation good for growth, as was urged by Economy Survey 2005 or we should insist on zero inflation only?

Un-scrupulous Economist & Rulers of the past:
Since 1972, I have seen hundreds of government Economist defending the government against grave crime of inflation. They always found some lame excuse or the other to defend the government. Like during 1972-76 periods when inflation of 150% was recorded, Oil price increase was pointed as the culprit absolving the Rulers of any wrong doing. Same argument was used for explaining high inflation in 2007 and 2008 period. All Economist and intelligent politicians, I sure know the real cause of inflation but do not say it in Public for fear of violent reaction of people. Since independence, successive government have used inflationary financing as the easiest means of raising funds. The ignorant Public was unable to protest effectively as with the help of paid Economist government was able to confuse the issue. Our media in 1972, and even 2009 was unable to bring the fact in front of the public and expose the Rulers. This is a shame at this time and age.

The truth about inflation:
In 1972, when country was dismembered and at least 30% economy was lost the money supply of Rs 14 billion was not reduced. In subsequent, two year additional Rs 8 billion was added to the money supply thus increasing the money supply to Rs 22 billion in nation, when it should have been around Rs 9-10 billion. The resulting 150% was a logical result of the extra money supply. The Oil price rose from 1974, on wards and as we ran a trade deficit at that time; therefore, the international inflation could not cause internal inflation. Because, we imported goods and services in excess of what we exported. Thus the foreign trade added availability of goods and services financed by external borrowings.

During 2004 and 2008 budgets were presented with remarkable gap in income and expenditure. The gap was always filled by borrowing from State Bank of Pakistan. As, SBP does not generate any deposits it lends money by printing extra notes. By July 2008, such borrowings reached Rs 700 billion. The amount was so large it led to 32% Food inflation by Aug 2008 while CPI was 25.3%.

IMF has compelled the Government to pay back about half of the borrowing by March 2009. This has eased the CPI inflation to 19.1% by March 09 while target for June 09 is 14%. As government continues to pay more the inflation will continue to ease and is expected to reach 10% by June 2010. When, all the extra money is drained out of the economy inflation will come to near Zero per cent.

Phillips curve applicability in Pakistan:
The fact that inflation led to higher interest rate was first established by Economist Phillips. His prediction seems to fit Pakistan’s experience since independence. When, ever inflation went up interest rate followed with a little gap. The rational is that when inflationary expectation is high savers demand an interest which ideally is above the expected inflation if not near it. Even slightly negative return is accepted but, there has to be a link with the expected inflation rate other wise, it would be better to spend the money on consumption or buying any material goods, price of which is bond to increase due to inflation. E.g.1. may buy a certain amount of steel, cement, cement blocks etc instead of placing a deposit in a Bank at a low rate.

From 2005, onwards interest rates started to rise and reached 20-22 % by end of 2008. This was in line with the inflation prevailing at the time. 

The high interest rate bought to the halt the booming consumer borrowing market and nailed down stock exchange. Fresh borrowing at 22% became unfeasible. While repayment with 22% mark up instead of 8% in 2005 made repayment very difficult leading to increasing default and social problems like suicides by borrowers.

Non inflationary borrowings by government:
Government has replaced SBP borrowing, with borrowing from National Saving Schemes by offering high returns up to 22%. The new receipts from these schemes are shown as revenue in the national budget although; it is a very expensive debt obligation and must be paid back. The other source is direct Bank borrowing. However, both these form of borrowing is not inflationary as some saver purchasing power is taken away and given to the government. Similarly, government borrowing in the form of Treasury Bills & PIBs etc auctioned through SBP is also not inflationary, as Banks channels consumer’s purchasing power to the government.

However, such borrowings reduce the available Bank credit to private sector and led to higher interest rate.

I recommend zero inflation:
No matter what others will recommend, I recommend a target of Zero inflation for all times to come to protect the economy from the ills of inflation and save masses from starvation as happening now. The number of poor in the country has jumped from 24% in 2005-6 to 36% by 2008 thanks to the barbaric inflation of up to 30% during the period.

I challenge, all Government Economists to debate this issue with me on live TV show and come up with any justification of economic cancer called inflation. I bet, they will note dare as they know, what they say for saving their jobs is contrary to the truth and not in the interest of the masses. With free media now they are afraid of the people’s backlash unlike in the past.

Conclusion and recommendations:

1. Inflation every where in the world is caused by excessive money supply? Any amount of demand push or supply pull can not generate general rising of all prices unless accompanied by excessive increase in money supply. The aggregate demand can not increase with out extra money supply.
2. In Pakistan, inflation has been used an easy source of revenue by all past Rulers. They were least bothered by its negative impacts as their rule was not dependent on the will of the people. Besides, people were successfully confused by giving alternative reason for rising prices? They were given the impression that this happens all over the world and is a natural part of modern economy. No one talks about zero inflation and interests of Japan for a long time or zero rate of inflation and 1% interest rate of US or 0.5% interest of UK and Europe. Even after 1974, oil shock the inflation in Japan remained zero although; as a second largest economy of the world, without any oil, Japan is one of the biggest consumers of imported oil. So was the case in 2008, when oil touched above USD 140 levels.
3. In recent history, when Musharraf came to power his Economic advisors resolved to bring down inflation from 12% to 4% and they did that by 2002. This was hailed as a most positive development; as indeed it was. They blamed excessive expenses of Nawaz government responsible for unacceptable rate of inflation and pointed out that high inflation was very bad for the economy. However, in 2005, the same government in its official publications like Pakistan Economic Survey started to justify 12% inflation as not so bad and in fact good for economic growth. Benefit of growth verses curse of inflation was debated in the papers to justify the 12% and above inflation then prevailing. They could not be right both in 2000 and 2005. If 2005 policy was right then the 2000 policy was wrong.
4. The Economic justification created in 2005 led to bigger and bigger budget leading to Rs 1.5 trillion budget of 2007-8 when expected revenue was Rs 1 trillion only. The huge gap of Rs 500 billion finally got finance by SBP borrowing of Rs 700 billion by Sep 2008. When IMF stepped in to bring discipline.
5. IMF should over look our monetary policy, for ever, as we are incapable of controlling our expenses and very lazy in tax collection. We have learnt the convenience of easy unlimited borrowing from SBP. By design 3 year contract Governors are bought from outside to comply with every request to print extra notes. Governors like Ms Shamshad Akhtar had no connection with the masses of Pakistan and she left the country at the end of her contract. Such transitory Officials are least bothered about the grave consequences of inflation on already to the bone poor masses.
6. Besides the IMF supervision, the Governor of SBP should be a person of great character and courage who should be able to withstand political pressure and deny request for excessive printing of notes. As a public figure, in-trusted with the task of protecting the purchasing power of the people, we should be ready to resign in front of the media after exposing the government.
7. In my opinion, the independence of SBP and National Debt office is more important than the independence of judiciary. Because, for the excess done to them people have alternative sources of remedy like taking law in their own hand or going to a Jirga while for the excesses done by printing of extra notes by SBP or National Debt office taking fresh loans internally or externally, they can not do any thing and silently suffer.
8.  A smart government in future will bring down inflation to zero and will make it possible for people to borrow at 4%. This will led to a boom in borrowing and huge spur in the economic activity and prosperity. Given the huge back log in demand like that of housing, cars, motor cycle, ACs, TVs the borrowing is likely to go much beyond the borrowing witnessed during 2002 and 2007 period. The peak borrowing in 2007 was reported to be 17% of household. If this borrowing reaches say 50% it will create a completely new economy. In the West, the borrowings have touched 90% of household. So, our touching 50% mark should be acceptable. As, this will create so many extra jobs that people will become scarce. This can led to higher real wages and decrease in poverty.