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A governance explanation of inflation
By: Dr Sajid Amin Javed
Inflation in Pakistan, especially food prices, is breaking all previous records. Measured at base year 2015-16, inflation in January 2020 increased by 14.56 percent compared with January 2019.
Inflation in rural areas stood at 16.34 percent. The data from Pakistan Bureau of Statistics (PBS) shows that increasing food prices are the main cause of inflation.
Consumer Price Index (CPI) for perishable foods — meat, poultry, fish, milk, eggs and many raw fruits and vegetables — increased from 91.86 in January 2019 to 163.94 January 2020, a growth of 78.47 percent.
CPI for non-perishable food items increased by 16.07 percent over one year. Many argue that perishable food items have only 4.99 percent weight in the CPI basket but this hurts poor the most.
Interestingly, PBS did not list a single food item recording a decrease in price in January 2020 compared with the same month last year. The prices of all items increased. Most importantly, the poor in rural areas are hit harder by inflation, compared to their urban counterparts.
The increase in price was higher for rural areas in almost all items. The prices of tomatoes, onions and potatoes recoded 211.18 percent, 136.63 percent and 111.24 percent increase in rural areas compared to 157.72 percent, 125.32 percent, and 87.3 percent in urban areas. The price of cooking oil increased by 29.29 percent in rural areas compared to 15.44 percent in urban areas.
The debate on inflation — and food inflation — has so far been limited to economic fundamentals. This may not suffice. The primary factor of governance gap, particularly at the lower level, is missing from the analyses. The otherwise negligible adverse impact of economic factors grows stronger when it multiplies with poor governance.
A recent study on Nigeria’s economic recession and inflation suggests that chances of price manipulation are higher in economic recession. Suppliers of goods and services use economic downturn in the country as reason to increase the prices. Increase in tax is used as excuse to increase in prices, which is multifold of the tax hike. Profiteering businessmen may increase the prices against exchange rate depreciation, even if there is no impact of depreciation on some of the products, basic food items, and household items that are locally produced.
Often, the increase in price is several times the perceived effect. Intuitively, goods and service providers are less inclined to abide by the government if “it is failing to mitigate the harsh effects of the recession”. This is where inflation becomes a governance issue.
Pakistan seems to have all the ingredients in place; the economic meltdown, depreciation; perceptions of inability of government to mitigate impacts of economic slowdown. In this situation, governance and (perception of) the writ of the government emerge as key factors to control inflation. In decentralisation, effective local governance takes central place. Role of monetary policy is limited, given the nature and drivers of inflation.
In this context, poor governance, particularly at the local level is one of the likely factors making present food inflation persist longer than expectations of the State Bank of Pakistan (SBP) and the government. Wheat replaced tomatoes and sugar replaced wheat as the commodity with a galloping price hike. We may soon see some other items replacing these as sugar and wheat prices stabalise at higher point. Managing the inflation will take governance, in addition to rational interest rate. Attempts to control prices through interest rates only are bound to be ineffective and counterproductive.
If the government is serious in responding to inflation, a crackdown on the markets will not produce the required results. It will rather create more panic, leading to even higher food prices. Similarly, the Qeemat app will not control prices. The government must restore local governments in whatever form it wishes.
In addition to other factors, abolishing local governments has distorted price setting and control mechanisms. Price control committees were highly effective in setting prices at the local level. These committees are now missing from the price setting chain. The perception of a government lacking the ability to enforce its writ is giving way to hoarding. Further, inefficiencies of the agriculture market in Pakistan are creating a huge gap between the farm gate prices and prices paid by the consumers.
The government has to make local price control committees vibrant if it is serious to manage inflation. Not only that the nature of present inflation is different, monetary policy is also in a fix. The interest rate hike should have been gradual. The SBP jumped to a very high rate.
Rising inflation is demanding a higher rate. This collision is creating panic in the business community, leaving the monetary policy almost ineffective. The SBP cannot cut interest rate-inflation and hot money and is not ready to up it because of businesses’ expectations.
Economic factors are also contributing to inflation. Government’s policy to meet the revised revenue target committed under the Extended Fund Facility (EFF) is pushing it to increase taxes on energy products, including petrol, diesel, electricity and gas.
The recent numbers from the FBR showed a shortfall of Rs 100 bn in January2020. Overall, the FBR is short of the target by Rs 387 bn. Till June, if there is no (mini) budget, the shortfall may reach Rs 700 billion. Entering into the second IMF review, achieving revenue targets is the obvious option.
The impact of the policies is highest on food inflation. Economic slowdown, originating from efforts to ‘successfully’ lower the demand have reduced demand for non-energy non-food items. But food items are relatively inelastic. Electricity price hike will increase the price of chakki atta and roti. Gas price hike is likely to add further to the trouble. Petrol price increases transportation costs. The impact is stronger if it happens every two months. That is why the core inflation did not pick proportionately.
If the government is serious in responding to inflation, a crackdown on the markets will not produce the required results. It will rather create more panic, leading to even higher food prices. Similarly, the Qeemat app will not control prices. The government must restore local governments in whatever form it wishes. It has to put price control committees in action with clarity of command chain.
It will have to increase the focus on supply chains of major food items to reduce supply uncertainties. Impact of all the measures largely depends on managing the perception of the government and its ‘inability to mitigate the harsh effects of economic meltdown’.
Food inflation may, however, come down in the next few months but that does not mean that these factors have improved. Rather, the prices will start coming down as food prices have reached the upper limits. For example, tomato prices touched their peak a month ago. Prices have to now fall — the ceiling effect. Compared to last month, tomato prices have come down by 8.36 and 8.22 percent in urban and rural areas respectively.

Source: https://www.thenews.com.pk/tns/detail/610873-a-governance-explanation-of-inflation

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The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.