Pakistan floods drown economy hopes

By Syed Fazl-e-Haider KARACHI - The floods scouring through Pakistan, in a catastrophe that may be bigger than the combined effect of the 2004 Indian Ocean tsunami and the 2005 Kashmir and 2010 Haiti earthquakes, are throwing into doubt all forecasts for an economy already struggling to survive amid terrorism, high inflation and widespread grinding poverty. The political outlook is also increasingly dark. President Asif Ali Zardari is facing heavy criticism after being in the United Kingdom and France while flood waters ripped a 1,000 kilometer path of destruction from the far northwest to southern Sindh province. The standing of the military, which is spearheading relief efforts, has

by comparison climbed. Religious groups are also welcomed by desperate citizens for the help they are providing. The damage has affected up to 14 million people and destroyed 650,000 houses, according to local estimates. As many as 4 million people have been displaced or made homeless and at least 1,600 killed. UN spokesman Maurizio Giulian told Associated Press that if the estimate is correct, the total affected would exceed the number hit by the tsunami and the two noted earthquake disasters of the past six years. Reflecting the chaos and outlook, stocks are tumbling, with the benchmark Karachi 100-share index dropping 2.8% on Monday to 10,026 and falling below 9,950 in early Tuesday trade. The country has suffered estimated losses of 40 billion to 60 billion rupees [up to US$800 million], Business Recorder reported, citing Farhan Mahmood, analyst at Topline Securities. This may be a gross underestimate. Farmers in northwestern Khyber Pakhtoonkhwa reportedly lost crops worth 35 billion rupees. The floods may cut economic growth by up to a half percentage point from the 4% growth target for the current fiscal year, the Topline report said. Inflation, meanwhile, is set to rise as the loss of crops drives up food prices and the government borrows more to meet relief costs. Entire towns, infrastructure, livestock and crops have been swept away. Electricity generation has been hit in a country already suffering crippling energy crisis. "The damage to crops, supply disruption of essential food commodities and the impact of reconstruction and rehabilitation costs on government finances has significantly increased inflation risks," The News reported, citing a Standard Chartered Bank report. Crops such as wheat, cotton, rice and sugar cane contribute about 7% of GDP. Inflation may climb to 12% over the next 11 months, against the government's 9.5% target, the central bank said. Headline inflation averaged 11.7% in the year to June 30, against a 9% target after increases in power and gas tariffs that are still feeding into the economy. The rise in inflation may prompt a 1 percentage point increase in interest rates by next July, which will force up business costs and hinder economic growth, analysts said. The fiscal deficit - the gap between what the government spends and what it raises through taxes - is expected to widen further, even beyond the central bank's forecast of 6% of GDP. That will take it above the 4% target that is one of the conditions attached to an International Monetary Fund bailout package initially agreed in late 2008 as the government struggled to meet international debt obligations. "If the fiscal deficit goes more than last year's expected 6% it would be disastrous for the country as it would face another spell of very high inflation which could force the State Bank to further tighten monetary policy," Dawn reported Mohammad Imran, head of research at Arif Habib Investment, as saying. The central bank in its most recent monetary policy statement at the end of July increased its key discount rate to 13% from 12.5% after refusing to accept the government's fiscal targets. "Fiscal pressures are expected to mount further [... on] expenditure for rebuilding the calamity-hit areas, and with tax exemptions being announced for them," Dawn reported Khurram Shahzad, Head of Research at InvestCap Research as saying. Extensive loss of crops, including cotton, rice, sugarcane and maize, threatens the government's 3.8% growth target for farm output this fiscal year. Damage to cotton n the Punjab may lead to higher imports, Bloomberg reported, citing the Pakistan Kissan Board, a farmers group. Rice exports may be cut after the loss of as much as 5% of the rice crop. The country will need billions of dollars more from international donors to recover from the floods, a daunting prospect at a time when the financial crisis has shrunk aid budgets in many countries. The US and other international partners have so far donated

tens of millions of dollars and providing relief supplies and assistance. The White House said US helicopters have helped to save more than 1,000 lives in Pakistan. Washington has provided US$35 million in aid, including 436,000 meals and 12 prefabricated bridges. The People's Liberation Army (PLA) of China has reportedly announced relief assistance worth 10 million yuan (US$1.5 million) in addition to 10 million yuan announced by the Chinese government. Last week, three Chinese aircraft delivered tents, medicines, water purifiers and generators to the country. Syed Fazl-e-Haider (http://www.syedfazlehaider.com) is a development analyst in Pakistan. He is the author of many books, including The Economic Development of Balochistan(2004). He can be contacted at [email protected].

Inflation and its impact on the Pakistan economy

Inflation is the rise in the prices of goods and services in an economy over a period of time. When the general price level rises, each unit of the functional currency buys fewer goods and services; consequently, inflation is a decline in the real value of money a loss of purchasing power in the internal medium of exchange, which is also the monetary unit of account in an economy. Inflation is a key indicator of a country and provides important insight on the state of the economy and the sound macroeconomic policies that govern it. A stable inflation not only gives a nurturing environment for economic growth, but also uplifts the poor and fixed income citizens who are the most vulnerable in society.

Causes of inflation

It has been generally agreed by the economists that high rates of inflation and hyperinflation are caused by an excessive growth in the supply of money. Today, most economists favour a low steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilising the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.

There are many causes for inflation, depending on a number of factors. For example, inflation can happen when governments print an excess of money to deal with a crisis. When any extra money is created, it will increase some societal groups buying power. As a result, prices end up rising at an extremely high speed to keep up with the currency surplus. All sectors in the economy try to buy more than the economy can produce. Shortages are then created and merchants lose business. To compensate, some merchants raise their prices. Others dont offer discounts or sales. In the end, the price level rises. This is called demand-pull inflation, in which prices are forced upwards because of a high demand, and excessive monetary growth. For inflation to continue, the money supply must grow faster than the real GDP.

Another common reason of inflation is a rise in production costs, which leads to an increase in the price of the final product. For example, if raw materials increase in price, this leads to the cost of production increasing, this in turn leads to the company increasing prices to maintain their profits, this kind of inflation is call cost-push inflation. Furthermore, rising labour costs can also lead to inflation, because workers demand wage increases, and companies usually chose to pass on those costs to their customers, this sort of inflation is called wage-push inflation.

Inflation can also be caused by international lending and national debts. As nations borrow money, they have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. A deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences in the import/export level.

Finally, inflation can also be caused by federal taxes put on consumer products. As the taxes rise, suppliers often pass on the burden to the consumer; the catch, however, is that once prices have increased, they rarely go back, even if the taxes are later reduced.

Effects and measurement of inflation

The most immediate effects of inflation are the decreased purchasing power of the rupee and its depreciation. Depreciation is especially hard on retired people with fixed incomes, as spending power decreases each month. Those not on fixed incomes are more able to cope, because they can simply increase their income. Another destabilising effect of inflation is that some people choose to speculate heavily in an attempt to take advantage of the higher price level. Because some of the purchases are high-risk investments, spending is diverted from the normal channels and some structural unemployment may take place. Finally, inflation alters the distribution of income. Lenders are generally hurt more than borrowers during long inflationary periods, which mean that loans made earlier are repaid later in inflated rupees. Inflation weakens the function of money as storage of value, because each unit of money is worth less with the passing of time. The progressive loss of the value of money during a period of inflation makes the borrowers to be less willing to use the money as standard differed payments.

To measure the price level, economists select a variety of goods and construct a price index such as the consumer price index (CPI). This is one measure of inflation. The CPI measures inflation as experienced by consumers in their day-to-day living expenses; it is the ratio of the value of a basket of goods in the current year to the value of that same basket of goods in an earlier year. By using the CPI, the inflation rate can be calculated. This is done by dividing the CPI by the beginning price level and then multiplying the result by 100. The GDP deflator is another very important measure of inflation as it measures the price changes in goods that are produced domestically.

Pakistan publishes four different price indices, namely: the consumer price index (CPI), the wholesale price index (WPI), the sensitive price index (SPI) and the GDP deflator. The CPI is the main measure of price changes at the retail level. It indicates the cost of purchasing a representative fixed basket of goods and services consumed by private households. In Pakistan, the CPI covers the retail prices of 374 items in 35 major cities and reflects roughly the changes in the cost of living of urban areas. The WPI is designed for those items which are mostly consumable in daily life on the primary and secondary level; these prices are collected from wholesale markets as well as from mills at organised wholesale market level. It covers the wholesale price of 106 commodities prevailing in 18 major cities of Pakistan. The SPI shows the weekly change of price of 53 selected items of daily use consumed by those

households whose monthly income in the base year 2000-01 ranged from Rs3000 to above Rs12000 per month. The SPI also informs about the actual position of supply: whether the commodity is available in market or not. If the commodity is not available, the reason for that is also recorded. It is based on the prices prevailing in 17 major cities and is computed for the basket of commodities being consumed by the households belonging to all income groups combined as in CPI. In most countries, the main focus for assessing inflationary trends is placed on the CPI, because it most closely represents the cost of living. In Pakistan, the main focus is also placed on the CPI as a measure of inflation as it is more representative with a wider coverage of 374 items in 71 markets of 35 cities around the country. Inflation has started veering its ugly head in many parts of the world, including Pakistan. Food inflation has emerged as the main contributor to inflationary pressures. (See Table)

The inflation rates based on CPI, SPI and WPI for the year 2008-09 increased by 22.35 per cent, 26.33 per cent and 21.44 per cent respectively over the corresponding period of 2007-08. It increased by 10.27 per cent, 14.09 per cent and 13.70 per cent respectively in 2007-08 over the corresponding period of 2006-07. In 2006-07, the rate of inflation increased by 7.89 per cent, 11.13 per cent and 6.92 per cent respectively over the same period of 2005-06. An analysis of data for last three years for the same period indicates that CPI, SPI & WPI were higher as compared to last two years. (See Chart)

The government is cautious about inflation and thus has taken various steps to release demand pressures on the one hand and enhance supplies of essential commodities on the other. To ease demand pressures, the State Bank of Pakistan (SBP) has continuously tightened the monetary policy over the last three years and more so in the current fiscal year, while to enhance supplies, the government has relaxed its import regime and allowed imports of several essential items so that there is a continuous flow in the supply of those important commodities. In addition, the government increased the imports of items like wheat, pulse and sugar to complement the efforts of the private sector. In order to provide relief to the common man, the government also increased the scale of operations of the Utility Stores Corporation (USC) which supplies essential commodities such as wheat flour, sugar, pulses and cooking oil/ ghee at less than the market prices.