Just when the economy had seen a fall in inflation, after application of severe aggregate demand squeeze policies, and a decrease in inflation globally as the supply chain crisis subsided, the federal budget announcing a significant increase in direct taxes– although mostly on the already taxed, while a number of big ticket sectors in terms of contribution to the economy like retail, and real estate still have very little direct taxation– along with deeply enhancing the extent, and depth of taxation of consumption (or indirect taxes), the decreasing trend of inflation has already reversed direction.
Moreover, together with a few budgetary, and overall economic policy initiatives on the supply-side, especially in terms of meaningful reform of the state-owned enterprises (SOEs), and energy sectors, inflation outlook is sadly strongly appearing to be difficult in the coming months. This is all the more painful, given inflation had come down from a very elevated position, where it remained quite sticky for a number of months– in terms of consumer price index (CPI), but especially for items of everyday use measured by sensitive price index (SPI).
The policy rate has lagged for a few months in terms of not remaining close to the CPI, whereby it is still at 20.5 percent– down from 22 percent, where it remained for many months– while inflation has come down close to 12-13 percent in recent few months. This will like build-up stagflationary consequences for the economy, both through cost-push inflationary channel strengthening, and the unfolding of the monetary policy transmission lag into the economy, among possibly other channels feeding into putting pressure on inflation, and downward pressure on growth.
Moreover, international oil prices are likely to remain difficult, since OPEC reportedly indicated that oil supply constraints will not be eased during this year. This will continue to build up pressure on inflation through the channel of imported inflation, while the significant increase in petroleum levy as per the federal budget’s announced policy action will once again add to a difficult inflation outlook.
Also, while inflation in the USA has come down, the US Federal Reserve has continued to remain cautious in terms of cutting the policy rate. A higher policy rate in developed countries means pressure on policy rate in developing countries to compete for foreign portfolio investment (FPI)– which is a wrong policy choice, since FPI or ‘hot money’ is highly volatile, and hence emphasis should be placed on building-up foreign direct investment (FDI), and for which an environment of more balanced approach of aggregate demand, and supply-side policies, which means a lower policy rate, producing a positive signal for FDI build-up– adding in turn, to a cost-push inflationary channel’s build-up in the country. In addition, a higher policy rate will also continue to contribute in terms of higher external debt distress.
The current federal budget’s acute pro-cyclical policy approach, and that too by placing more emphasis on increasing revenue through enhancing indirect taxes, not only will likely put greater inflationary pressures, but will also produce negative impact on economic growth, and likely increase poverty, and income inequality in the country.
At the same time, Pakistan has entered into an Extended Fund Facility (EFF) programme with the IMF, which would mean likely continuation of fiscal consolidation (or austerity-based) stance, in addition to following a pro-cyclical policy. As per the July 12 IMF press release ‘Pakistan: IMF reaches staff-level agreement on economic policies with Pakistan for 37-month Extended Fund Facility’, whereby it was pointed out ‘Sustainable public finances, through a gradual fiscal consolidation based on reforms to broaden the tax base and remove exemptions, while increasing resources for critical development and social spending. In this regard, the authorities plan to increase tax revenues through measures of 1½ percent of GDP in FY25 and 3 percent of GDP over the program. In particular, the recently approved FY25 budget targets an underlying general government primary surplus of 1 percent of GDP (2 percent in headline terms).’
This, in turn, would mean over-reliance on aggregate demand squeeze policy being employed to control inflation, which has been shown to be counter-productive, since it builds-up cost-push, and imported inflationary channels; not to mention adding to debt distress, and producing negative impact on economic growth prospects.
Moreover, the current federal budget’s acute pro-cyclical policy approach, and that too by placing more emphasis on increasing revenue through enhancing indirect taxes, not only will likely put greater inflationary pressures, but will also produce negative impact on economic growth, and likely increase poverty, and income inequality in the country.
A July 4, Bloomberg published article ‘Pakistan imposed a milk tax, now the dairy staple costs more in Karachi than Paris’ highlighted the over-emphasis on not just taxation, but imposing taxes on essential items like milk. Hence, the country’s policymakers rather than meaningfully broadening tax base, have wrongly placed consumption taxes on a number of essential items like medicine, and milk, especially when more than one-third of the country’s population is under the poverty line.
The article pointed out in this regard ‘Milk prices in Pakistan surged by more than a fifth after a new tax was applied, making the dairy staple more expensive than in France, Australia and some other developed nations. … Costlier milk will add to rising inflation in the South Asian country, where wages have stagnated, eroding spending power. The increase may also worsen child health. About 40% of the nation lives in poverty. … About 60% of Pakistani children under 5 years suffer anemia and 40% suffer from stunting. Pakistan raised taxes by 40%, the highest on record, in last week’s budget aimed at meeting conditions set by the International Monetary Fund for a new bailout.’
