Inflation and State Bank independence

Critics will argue autonomous SBP cannot help in achieving economic growth

LAHORE:

The economy has been witnessing heightened political volatility over the past six months. A series of events have increased economic uncertainty.

Although meaningful structural reforms remained a challenge for the current government, these events added fuel to the fire in this vein. In addition, the intermittent nature of pandemic is not allowing certain business firms to operate at the optimum level.

The economy has been stagnant since FY19. In the beginning, the balance of payments (BOP) situation compelled the government to slow the economy down and we witnessed a low gross domestic product (GDP) growth rate.

In FY20, the slowdown deepened further due to Covid-19 and the GDP growth turned negative along with a double-digit inflation. In FY21, the economy is experiencing a slow growth along with a high inflation.

Average inflation remained at 8.25% in the first eight months of FY21, though it subsided between November 2020 and January 2021. After this interlude, the inflation accelerated in February 2021.

The Sensitive Price Indicator (SPI), which measures prices of 51 essential commodities, is continuously in double digits. These prices affect the masses a great deal. High prices indicate that the economy is in slumpflation and is gradually moving towards stagflation.

Although the government administers prices of essential commodities and regulate the energy and fuel prices, the double-digit inflation will remain a challenge under the emerging situation.

Every now and then, important roads are choked with marches and protests. For instance, doctors demanded a better pay package, paramedics asked for improved service structure, engineers staged protests for technical allowance, a clerks union raised its concern and the government bulged.

Whenever there is a double-digit inflation, the government has to raise the salary of its employees, though it tried to resist in the beginning. The purpose of resisting the pay rise was to minimise the fiscal deficit, which could not happen as the deficit has become structural. However, the deficit is usually financed through the monetisation process.

The resumption of Extended Fund Facility (EFF) of the International Monetary Fund (IMF) has required certain quantitative restrictions on the fiscal deficit. The IMF suggests reducing the fiscal deficit with every passing year of the programme.

In order to apply a technocratic solution, this time around, the IMF has asked for the independence of State Bank of Pakistan (SBP). Although the finance ministry resisted the move for a year, the table turned in favour of the central bank.

The cabinet has granted independence to the SBP from government control. Therefore, the Monetary and Fiscal Policy Coordination Board will be abolished, which was playing an important role in coordinating fiscal, monetary and exchange rate policies in the country.

The above step has been taken to minimise political intervention by the government in the affairs of economy since politicians follow a soft budget constraint and spend superfluously to appease their voters.

Critics would argue that the independent central bank could not help in achieving the long-run goal of economic growth. They will further state that inflation will be controlled at the cost of economic growth.

A few would argue that this experiment would be a failure in the context of a developing country like Pakistan.

In a nutshell, the purpose of an independent SBP is to restrict political intervention by the government in economic management. This is a new experiment in the context of Pakistan.

The question arises whether the independent SBP will help in addressing stagflation or not. Let us see how the political government would cope with the emerging situation.

The writer is an Assistant Professor of Economics at SDSB, Lahore University of Management Sciences (LUMS)

 

 

Published in The Express Tribune, March 15^th, 2021.

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