Pakistanis demand end of  inflation
By: Tarique Khan Javed
President, Overseas Pakistani Investors Forum.

The phenomenon of continuously rising prices, of all commodities, commonly known as Inflation is the most hated aspect of national life. Everyone talks about it day in day out as nothing hurts them more than this bitter truth.

People are resigned to take this as something granted like a natural calamity about which nothing can be done. However the fact is that it is  very much possible to have an economy with NIL or very low level of inflation, that too only  for short duration .

Inflation a problem of unsound and unfair economies:
Sound economies do not suffer from the decease of inflation. Countries like Saudi Arabia, UAE, Japan, USA, UK, Germany, Singapore manage to run their economies by having NIL or very low inflation rate within the range of 1 to 3 %.
Yet they achieve the desired growth rates, maintain stable exchange rate, stable interest rate and  promote savings. All this provide condusive atmosphere for internal and external investment and job creation leading to real increase in wages and standards of living.
Unsound economies run by unprofessional or dishonest Economic Managers on the other hand use  the facility of printing notes as a easy means of raising funds knowing very well that it will lead to inflation. Which in turn will raise the interest rate based on expected inflation, gradually depreciate the currency as the nominal internal costs will go up due to inflation, and therefore to keep relative price comparable to competing countries  exchange rate will need to be adjusted downwards. As the inflation eats up  value of saving the incentive to save is reduced and people think it is better to consume now rather than on a future date. The rate of return on saving in such situation is often negative after deducting the prevailing inflation rate.
However the most upsetting and inhumane effect of inflation is the erosion of purchasing power from all segments of the society without any distinction. Price rise effects a bagger, a wage earning, a land less peasant, a fixed income employee and a very rich person equally. While people with property recoup their losses by having higher value of their properties people without property are pushed deeper and deeper into poverty.  

Printing of notes to finance the growing economy both formal and Black is not inflationary as long as it does not exceed the growth rate. Thus every Government in the World has a hidden source of income in the form of funds available from printing additional notes. The higher growth rates provide more funds. Greedy Rulers go on  printing notes beyond  what can be absorbed, leading to inflationary situation.   

The difference between Incentive based price increase and Inflation:
Price of a commodity rises when for what ever reason its demand exceed supply. This is markets response to the shortage to encourage higher production in the coming years. Similarly a drop in price is a signal to the market that the production is in excess of the demand and thus telling producers to cut production in future.
The increase in price of one or two commodities at any given time can not be called inflation.
Because such increase compels consumers to forgo some other demand of theirs. Thus the total demand does not go up. The payment of high price for some commodity like Oil can make the consumer and the Oil importing country like ours poor and Oil exporting countries richer. However this can not cause inflation.
In the long run the market forces acts and bring down prices as seen in the case of Oil when due to over supply situation oil price touched  USD 8-10 per barrel during 1998 leading to budget deficits in countries like Saudi Arabia.

Mild rate of inflation between 1950-1971.
In the case of Pakistan till 1971 the problem of inflation was not a serious one as Economic Managers agreed that inflation was destructive for the society and thus was to be avoided.
Thus between 1950 and 1970 the  Total volume of Bank Notes increased from Rs 1.84 billion to Rs7.71 billion up 314% or 15.95% pa .
In 1971 this increased to Rs 8.97 billion however after separation  of Bangladesh the Bank Notes were reduced to Rs 5.88 billion(down by 30% to account for the lost economy) to cater for need for a smaller economy of West Pakistan.
The rate of inflation during this period on the average was maintained at  3.1% pa .
Even this rate of inflation was unnecessary and undesirable yet acceptable for a newly independent country learning how to manage the economy.
The fact that inflation increased by only 3.1% while currency increased by 15.95% during the period indicates that after accounting for economic growth rate of say 6% on the average, the remaining money 15.95-6-3.1=6.85%  was absorbed by the informal economy. The fact that the formal economy absorbed 6% while informal economy absorbed 6.85% indicate that the informal economy was 114%  of  the size of formal economy, during this period.

PPP Government and the rise of high inflation- 1972-1978.
Ironically it was the Pro poor Government of PPP which started whole sale printing of notes. By 1978 currency increased to Rs 20 billion up 240% over 1972 level  or 34.25 % pa. This caused a rapid surge in inflation, which was more disturbing to the economy and people than the effect of Nationalization.
With economy is disarray following nationalization, the rate of inflation during this period averaged 14% per annum and caused misery at a massive scale.
The all ready hand to mouth people barely surviving found that their means of survival was snatched away by a very clever means without any thief or dacoits even coining to their houses. People in high places managed to take away their money and use it on themselves without taking the pain of coming down and asking for it.
 Bhutto blamed increase in OIL price for the inflation ignoring the fact that Oil price increased started in 1974. He and his economist refused to accept that more than doubling of currency had any thing to  do with the unbearable inflation .They refused to accept the difference between incentive based increase in price and inflation.
Based on my econometric model and Government data, I was able to prove in 1976 that inflation at that time was due to excessive printing of notes rather than any other factor. This finding was published by DAWN as a leading article.

General Zai era  of moderate inflation- 1978-88
General Zai learnt form the mistake of Bhutto and tried to restrict the use of printing press and used borrowing from Public directly as the sources of deficit financing. Very high rate of return upto 18% was paid on Government deposit schemes to attract funds at the cost of  Commercial Banks and in turn reduced financing available for
business
Yet by end of  1988 currency increased to Rs 93.4 billion up by 367% over 1978 level or 33.36% per year on the average.
The increase was almost same as previous period however  Inflation remained lower at around  7% pa partly because of  good economic growth rate of 5-7 during this period.
During this period out of the absorbed monetary expansion of  33.36- 7(inflation) = 26.36%  growth in informal economy consumed 7% while 19.36% was absorbed by informal economy. Implying that  informal economy was  2.77 times the size of  formal economy. This was the time when USA pumped billions of dollar into Afghanistan mostly through our informal economy.  

Banazir/Nawaz ear of high inflation- 1988-1999.
During the weak governments of Banazir and Nawaz printing of notes became more common and borrowing from people was reduced. 
By 1990  total currency  reached 120.8  billion level  and  by  Dec 1999 it reached Rs 365 billion level up 290% over 1988 figure or 26% annually.
Inflation remained high during this period averaging around 10% pa partly due to depressed economic growth rate of about 3%  during this period.
During this time out of  absorbed  monetary expansion of 26%  less inflation of 10% or 16%,  only 3% was absorbed by formal economy balance 13% by informal economy implying that the size of informal was 4.3times that of formal.  

 General Musharraf era of low inflation- 1999- till date
By end of Dec 2000 currency increased to Rs 432 billion(+ 67 billion or 18%),
 by end 2001 to Rs453 billion(+ 21billion or 5%),
 by end 2002 it reached Rs 515 billion(+62 billion or 13.7%),
 by end 2003 it touched Rs 600 billion mark(+85 billion or 16.5%),
 by end 2004 Rs 697 billion(+97 billion or 16%)  and
by June 2005 it arrived at Rs712 billion level (+15 billion or  4% pa ).

Thus over Dec 1999 figure the increase in currency upto June 2005  was 95% or 17.27% annually. Much  lower than in previous periods.
Therefore between 1999 and 2003 Pakistan enjoyed low inflation rate of 3.6% pa..
However the lagged effect of  increasing level of printing of notes during2002-5 period, as detailed above, has started to exert pressure on prices despite impressive economic growth rates.
Thus from the low of 3.1% during 2002-3 period when growth rate was 5.1% it jumped to 4.6% during 2003-4 period despite better economic growth rate of 6.4%.
This rate further jumped to 9.3% during 2004-5 period although the economic growth rate was 8.4%.
On the whole the period of 1999-2005 was good as average economic growth rate was 4.9%  while the inflation averaged 4.7%
 For the on going financial year estimates vary for inflation. While private economists think the rate is some were close to 12%, Government claims that the rate has been contained at 8% during recent months(April 2006).
During  this time out of absorbed monetary expansion of 17.27% less inflation of 4.7% or 12.57%, formal economy growth absorbed 4.9% while the informal economy's growth absorbed 7.67% assuming that the rate of growth of both economy was same. This implies that the size of informal economy shark to 1.57 times that of formal. A major improvement over previous period..

Achievements of the present Government and limitations:
Besides low inflation rate as illustrated above the present  Government has done a lot of good to reorganize the economy. One of the most important achievement is the reducing and rescheduling Total debt (now USD 72 billion-half domestic) which had reached 93% of GDP in 2001 to 63% by 2005. Similarly the total debt service ratios  was brought down to 40.6% of Tax Revenue by 2005 compared to 77% in 2001.
However the issue of  budget deficit is a tough nut to crack even for this Government.  

Structural changes required for a balanced Budget.
Government of Pakistan is historically very weak and ineffective. It has  always failed to collect taxes from bulk of its citizen. In early years (2000) of the current government, major effort was made to broaden the tax base, however nothing came out of it.
Currently only 1 to 1.5 % of the population pays direct taxes while rest manage to keep away, forcing government to rely upto 60-70 % on indirect taxes(69% in 2004-5), which is very cruel as it impacts the poor sections heavily.
In recent years this narrow tax base has yielded increasing revenue which touched Rs 630 billion mark during 2004-5 period. Government is aiming to take it further to Rs 835 billion for year 2006-7 period.
However since 1985, what ever Net Revenue is collected gets used by three major Non-development expenditures namely General Administrative, Defense and Debt Service.

Budget of 2004-5 (actual realized)
Out of Net Revenue receipts of  Rs 747 bio including Rs 117 bio Non Tax Revenue:
- Debt repayment and interest consumed  Rs 274 bio. 
- Defense Affairs and Services consumed Rs 246 bio.
- General Administrative Expenses consumed  Rs 249 bio.

Thus Total Current Expenditure stood at Rs 785 bio or Rs 38 bio more than Net Revenue receipts. With Development Budget of Rs 202 bio Total Expenditure stood at Rs 987 bio. Resulting in Total budget deficit of Rs 246 bio.
The deficit was financed to the extend of Rs 141 bio by External Finance (UN and other   payments)  and remaining by State  Bank borrowing (81 bio) Non Bank borrowing (13.3 bio) and Privatization Proceeds (10 bio).
It is clear that Pakistan is in dire strait; it needs to spend money on development and poverty elimination yet it does not have the resources.
The External finance which has helped pay big part of the budget deficit can not be relied upon as a stable source of fund thus  we need to find some ingenious means to get rid of one of our major current expenditures like Debt repayment.  In this connection I suggest following radical measures:

Revenue Side:
1. To start with Government should get rid of the record number of Ministers and merge number of Ministries to have a small government, in line with current trend in the world. Big Government lead to corruption and retard business due to unnecessary interventions. Government should aim at cutting the
General Administrative expense to half. This should release some Rs 100 billion for other uses.

2. In line with international practice, the government should consider  relocating all military installations out of cities and selling all defense related land in  cities, in general auction. The auction organized in the manner in which government land are auctioned on Internet by Governments of Hong Kong and Singapore, should fetch enough money to help Government pay off its domestic and foreign debt thus reducing a major expense of Interest and Debt repayment and releasing about  Rs 250 billion for other purposes.
One Real Estate expert has estimated that sale of all Military land in Karachi alone can yield Rs 2 trillion enough to pay off all domestic debt and save Rs 180 billion in interest payment alone. Sale of land in other cities perhaps can bring another Rs2 trillion which can settle all external loans of USD 35 billion(or Rs 2.1 trillion).
Alternatively the realized funds of Rs 4 trillion, may become reserve fund  for the Defense Ministry to be used for its budget for 16-18 years, thus reliving the pressure on budget/people by about Rs 250 billion.

3. The government rate of rent of leased lands should be bought in line with existing commercial rates. The current rates fixed during British Raj and still continued today with small adjustment are a joke and loss of huge potential income for the Government. Fair lease rates should boost government revenue substantially.

4. Auction of all Government land should be done through Internet, so that cornering by a small group of people is done away with and correct price is obtained for national assets. This measure should enhance government revenue many fold and end the current state of helplessness.

Expenditure Side:
Assuming that an additional sum of Rs 400 bio becomes available for Expenses, this sum may be allocated as follows:

1. The  budget for Health Affairs and Services which was Rs 3.3 bio in 2004-5, may be increased to say Rs 60 bio.
 
2. The budget for Education Affairs and Services which was 12.2 bio in 2004-5 may be increased to say Rs 100 bio.  

3. The budget for Housing & Community Affairs which  was Rs 0.9 bio in 2004-5, may be increased to say Rs 30 bio.

4. The budget for Recreation, Culture and Religion which was Rs 2.2 bio in 2004-5 may be increased to say Rs 30 bio.

5. The budget for Social Development in the 2004-5 Development  Budget was Rs 50.4 bio, this may be increased to say Rs 100 bio.

6. The budget for Provinces in the 2004-5 Development budget was   Rs 54 bio this may be increased to say Rs 100 bio.

7. The total subsidies in 2004-5 budget was Rs 51.4 bio out of which Rs 22 bio went to WAPDA and Rs 9.7 bio to KESC, "OTHERS" consumed Rs 19.7 bio.  As the payment to KESC will now cease, funds saved plus additional sum of say Rs 100 bio may be used to provide subsidy for essential food items like Wheat, Pulses and Cooking oil.

 Over view 1950- 2006
 It is clear that the total increase in currency was much beyond the increasing needs of the economy even after accounting for substantial informal economy.
The rate of growth of money is far in excess of the growth of economy thus the prices of all commodities have increased many fold and in the process made the lives of poor people miserable.
Given that Pakistan has a substantial "Black Economy" which absorbs significant amount of excessive money, the inflation in Pakistan is always below what would otherwise would have been. In that sense the "Black Economy" is a major blessing in disguise and source of funding for the Government.

Conclusion:
Inflation plus Indirect Taxes like Excise and Custom duties are the means used by different governments to punish and torture common people into submission so that they can never think beyond day to day survival. 
At a time when people are rising against unjust systems in Latin America and lately in Nepal. We  need to end the ever present curse of inflation and provide  some  relief to the masses.
 Besides inflation, indirect  taxes also need to be reduced radically, to lessen the burden of taxation on common people.
 Time has come to change what has been going on for long.
The current Government should initiate some bold measures that will tackle the root cause of inflation-budget deficit.
It should also resolve never to use the facility of printing notes beyond the projected rate of growth of formal and informal economy and take corrective measures if the target seems to be changing for what ever reason. If so done inflation can be maintained at Zero level or plus minus 1%.We may learn form Central Bankers of  Japan, Saudi Arabia and UAE as to how this is done one day to day basis.
From the above analysis it is clear that the real size of economy is much bigger than the GDP of  Rs 6 trillion (or USD 100 billion). Very large tracks of economy is beyond the reach of weak Government of Pakistan,  partly due to rampant corruption in  the society where finding a man of integrity is an uphill task.
Latest money growth and inflation rate suggest that the size of informal economy is 1.57 times the size of formal economy. Thus the size of informal economy is 6X1.57=9.42 trillion and therefore the real total economy is worth Rs 15.42 trillion (or USD 260 billion).
Therefore if the projected growth rate is say 6% and Government end up printing say 12% more currency, we should not see any inflation in Pakistan. Any expansion beyond this, as in the recent past, will lead to inflation.
At the last reported level of Rs 712 billion  currency, it means that Government has  a source of deferred liability fund of Rs 85.44 billion per year. This  is quite substantial. 

Recommendation:
1. Government of Pakistan should adopt the goal of achieving zero inflation rate as a major national policy linked  with aim of poverty containment.
 
2. The maximum allowable printing of Notes should be liked to expected economic growth rate in both formal and informal economy.
Based on latest evidence expansion at double the rate of growth in formal economy may be allowed. However this must be quickly adjusted if evidence of inflation surfaces.

3. Radical measures as explained  above, needs to be taken to expand Tax Revenue and achieve a balanced budget. Also the ratio of Direct taxes to Indirect taxes should be changed from current 30:70 to 60:40 as part of national poverty containment objective. 
 
4. The Governor of State Bank should be entrusted with the task of ensuring zero inflation in future and be made completely independent like the US Federal Reserve Chairman.

5. To ensure that State Bank is able to resist the day to day  pressure from the Government, I suggest that the position of Governor of State Bank of Pakistan be made one of the most important and trusted  political position, to be manned by a  well known national figure. Who would be the guardian of Peoples purchasing power and thus well being.
Such person would not be bothered about losing his job, while carrying out the task of maintaining/preserving the value of Pak Rupees and making SBP independent of Government pressure. He would take oath in front of people of Pakistan that he will keep the Inflation at zero or plus minus 1% rate  at any cost and if he feels that he can not  do so, will report to the Public and resign.
I suggest the name of Mr. Ghulam Mustafa Khar, Retired  General Aslam Beg,and Mr.Imran Khan for this position.