Genesis of Pakistan's recent inflation: The News

Dr Meekal A Ahmed

Pakistan has typically been a low-to-moderate inflation country. Taking a long-term view and excluding outliers, or periods of exceptionally high or low inflation, inflation has averaged about 6.5-7.5 percent per annum. This is a remarkable record for a developing country.

However, in recent years inflation has become a serious economic and social issue. From 2 percent during the period of 9/11, admittedly an unusually low starting point, inflation accelerated, reaching a "headline rate" of around 25 percent, a level never witnessed in Pakistan's economic history. Such a high rate of inflation is not, as some would have us believe, due to "exogenous shocks" beyond the control of policymakers. On the contrary, this inflation was largely policy-driven, as reflected in the fact that the "core," or "underlying" rate of inflation, which strips out the volatile components of inflation such as the price of food and oil that are due to exogenous shocks, also accelerated from, say, a core rate of 1 percent per annum to 18 percent over this period.

Nor did inflation start out of the blue, at the end of the golden era of General Musharraf. Inflation invariably has its genesis far back in time.

Pakistan's recent inflation experience is the consequence of short-sightedness, an incapacity to look ahead, and economic policies that were inherently flawed, driven by a debt-fuelled consumption bubble (now coming home to roost in the form of rising non-performing assets of the banking system), and excess levels of liquidity in the economy which spilled over into speculation in real estate and the stock market. Growth was not driven by the more self-sustaining forces of investment, productivity improvements, structural reforms, and net exports.

In the initial period, an increase in the rate of real GDP growth took place in an environment of relative price stability. Yet, to the discerning eye, it should have soon been clear that the pressure on resources was slowly building-up. Economic growth moved above trend (we hear about 7.2 percent GDP growth ad nauseam), operating with what economists call a "positive output gap." Absent any offsetting rise in productivity, which would have helped mute the inflationary strains being imposed on the economy of a positive output gap, the core rate of inflation started to gather speed.

It is the behaviour of the core rate of inflation that should have prompted policy action. However, the clear and obvious signs of accelerating core inflation were ignored and, with no effort being made to rein in demand pressures amid a widening positive output gap which reflected itself in growing macroeconomic imbalances, inflation started its deadly upward course. It has landed the economy in the worst economic slump and high inflation environment ever experienced in 62 years, with soaring unemployment and deepening poverty. To be sure, this high-inflation-low-output-growth stagflationary trap has been exacerbated by crippling power shortages, exogenous shocks, security issues, lingering economic uncertainty, and a global recession. But these factors exacerbated inflation; they did not cause it.

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