Politics of inflation

The article is published in the Money Matters on 25 Nov 2013

Every political party emphasises the need to reduce inflation, create employment and alleviate poverty before elections. Inflation and unemployment are among the major concerns for policymakers as well with both variables of core importance while making macroeconomic policies.

Inflation is currently on the rise and it is expected that it will reach double digits in the current fiscal year against the target of 9.5 percent. The State Bank of Pakistan (SBP) has recently increased the discount rate by 50 basis points to reduce inflation. The PML-N government has been under attack since it came into power by other political parties as well as its critics due to the increase in inflation. The policies of the current government are being held responsible for higher than expected inflation. The agreement with the IMF is also severely criticised for playing a role in increasing inflation while some critics associate the programme with excessive borrowing by the government, buying foreign exchange from the market and depreciation in the exchange rate.

Economists, in general, associate inflation to the money supply in the long run, especially the excessive money supply. However, researchers have also tried to link inflation with the political economy, fiscal and structural variables. Without any doubt these variables have some effect on inflation in the short run but in the long run the sole determinant of inflation is money supply.

Contrary to these popular beliefs, an excessive increase in current inflation can be linked to four political factors which are strongly associated to the 2013 elections. However, in the end we’ll see that political factors are subjective and in reality it is the money supply which contributed to inflation only.

The federal government as well as the provincial governments increases their spending on the development projects before the elections to show their determination and commitment to development of Pakistan. The increase in development expenditures from 3.6 percent of GDP in 2011-12 to 4.4 percent of GDP in 2012-13 strengthens our claim that excessive money is spent on development projects before the election year. Thus money/funds which were hoarded are spent before the election to gain support of nation to vote for them.

Subsidies are among the most important variables which negatively affect inflation in the short run but in the long run they may affect the inflation rate positively depending on the financing process of subsidies. However, subsidies given to the farmers in the name of support price lead to an increase in inflation. Therefore, the nature of subsidies is also important. It can be in the form of cash transfers such as income support programmes, support price to specific a sector, interest free loans or loans provided at a lower rate than the market prevailing interest rate such as an export finance scheme, tax holidays and rebates to different sectors such as duty drawback to the export sector. Before the elections subsidies are also used to control the prices if they are expected to go up. The best example in our context would be subsidies given to the energy sector. Circular debt was the outcome of several subsidies given by the government not to increase the price of electricity.

An excessive increase in the money supply to mitigate the gap between potential and actual employment is a major socio-political economic policy. This policy leads to trade-off between inflation and employment since increase in money supply may increase employment in the short run but eventually contributes to inflation. However, excessive monetary borrowing was carried out to finance the budget deficit before the elections and continuous purchase of domestic assets to increase foreign exchange injections into the market to control the exchange rate may not give us a clear illustration of our claim. 

Moreover, money spent on election campaigns including public meetings, poster printing etc increases domestic commerce activity. Politicians and political parties spend billions of rupees on their election campaigns every five years. The money hoarded by either politicians, political parties or their financers is given to the people who are involved in their election campaigns.

Furthermore, black money is also involved in elections, which is either used to gain the support of leaders in the villages or given to their workers, mostly belonging to lower middle class who will do various chores for them related to election campaigns. Nevertheless, money circulation will increase in the economy which increases the purchasing power of the people to spend on various items, particularly food. Therefore, expectations of an increase in the purchasing power lead to increase in food prices. This is also evident in the first three months of the current fiscal year with food inflation more than non-food inflation, opposite to the trend in 2011-12.

The above discussion on a possible increase in inflation is based on politics. However, each case presented in this article is related to circulation of money in the economy which leads to inflation. Research tells us that the impact of money supply affects inflation with a nine to ten month lag. The effect of money supply on inflation may take more time if it is hoarded by people or institutions for a longer period. Therefore, we can conclude that current rise in inflation is the lag effect of previous year’s policies of the last government which are strongly associated with the 2013 elections and the money spent on elections by politicians and political parties. Moreover, as economists suggests it is the money supply which is the sole determinant of inflation.

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Difference between mutually exclusive event and independent event

While teaching course of Statistics at PIDE I realized that students are in general confused between mutually exclusive events and independent events. Since I taught this concept recently thus i thought that i should upload the explanation. There are good chances that some other websites have explained this as well.

Mutually Exclusive events are those events which cannot occur together/simultaneously. Moreover in simpler words if certain events cannot happen together at the same time then those events are known as mutually exclusive events.
For Example: (1) Its raining outside and it's not raining outside (2) he had tea in office and he did not have tea in office (3) arrow hitting a dart and not hitting a dart (4) cyclone happen and not happen (5) sick and not sick. All the examples are very clear that  these events can occur at the same time.
Independent Events are those event which can occur together but there is no association between them. For instance (1) it will rain today as well as we will have too much work in office (2)Teacher will take a class and painter paint a portrait (3) purchase a computer and eating eggs in breakfast (4) elections in India and tree plantation in England. All the examples show that the events can occur at the same time but there is not correlation between the two variables.

Addressing Electricity Shortage through Electricity Conservation

Published in Money Matters, November 4, 2013 entitled "Energy: Tackling the Crisis"

Pakistan has been facing a severe energy crisis since 2007, which has badly affected its industrial sector. The main reason for the crisis is that in the past, efforts were not taken to enhance the power generation capacity by installing new plants or building new dams.

The CNG policy has proved to be another nail in the coffin. But the new government has been contemplating to abolish its supply to vehicles, especially in the coming winter in order to provide continuous supply to households as well as to the industrial sector.

Addressing energy shortages has been one of the main priorities of the PML-N government. In fact, Prime Minister Nawaz Sharif’s first public speech (right after winning the elections) focused on addressing electricity shortages. And his political party started working on mitigating the crisis in the quickest time possible by signing international and national contracts for electricity generation as well as paying off a part of circular debt.

According to studies conducted by Pakistan Institute of Development Economics (PIDE), governance, capacity issues and circular debt are the major factors behind the crisis. The crisis can be mitigated by resolving any one of these three issues and can be completely abolished by simultaneously addressing all the three issues.

Apart from that, a USAID and Planning Commission’s Framework for Economic Growth (FEG) report emphasised on governance issues to eradicate the issue of circular debt as well as making circular debt part of debt financing.

The severity of the energy crisis has been increasing since 2007. Undoubtedly, the new government is adamant to eradicate the crisis but it would take three to four years to overcome energy shortfall. Governance, as stated in the Planning Commission’s FEG report, is among the quickest ways to lessen the crisis. Another equally important step, which has been deliberated for weeks by Federal Minister for Water and Power Khawaja Asif, is of energy conservation.

Several energy conservation strategies have been implemented in the country, such as use of energy savers, implementation of daylight saving time (DST) plan and early closure of markets. However, these strategies have failed to achieve the desired result. Let’s take a look at the three strategies:

Daylight saving time (DST) helps conserve electricity by reducing the gap of excess demand, especially in summers. This enables individuals to use an extra hour of daylight in evenings by making use of less artificial lights.

Daylight saving time has been implemented thrice in the country since its inception. As energy demand increased in summer, daylight saving time was implemented for the first time in 2002 from April-October. Thereafter, it was executed again in 2008 from June to October and April to October in 2009.

The daylight saving plan has mostly failed in the country due to non-acceptability. Generally, people used to change their work hours with the plan, which subsided the impact of advancing clocks by an hour. At the commercial level, a minimum of one hour of electricity was saved by the end of the day.

By spreading awareness and executing proper research, the government can implement the daylight saving plan more effectively.

The use of energy savers helps save electricity but it doesn’t reduce consumption. Hence, it is an energy efficiency strategy. Despite the fact that the use of energy efficient appliances have been on the rise since the last one decade, it is difficult to ascertain if the overall consumption has decreased.

Early closure of markets is a vital policy that can save electricity. But either the authorities are fearful of retailers/wholesalers or there is a lack of will as it has not been implemented effectively. In Europe, more than 95 percent of markets shut down by 6 pm or 8 pm and if the same policy is implemented in Pakistan, customers will adjust to timings and thereby save significant amounts of electricity.   

Although not a popular measure, increasing electricity prices will compel the consumers to reduce its usage. We recently experienced the reaction of the people, political parties and even the Supreme Court when the government announced rise in electricity prices. Rationalisation of electricity prices is important – be it producer or consumer price rationing.

Similarly, there are certain measures that can be taken at the individual level to conserve energy. These include: building energy-efficient buildings, less use of high electricity consuming appliances and creating awareness campaigns.

The abovementioned conservation strategies can be easily implemented without increasing government’s expenses. Thus, the government needs to pursue different conservation policies by coordinating with households and industrialists.

Most importantly, implementation is the key to get the desired results. Remember, a megawatt saved is better than a megawatt produced

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PML-N Government: A Long Way to Go

Article is published on 30 September 2013 in Money Matters

	ECONOMY

	A long way to go

Before the govt of PML-N took charge of the office I wrote an article on economic revival based on the manifestos of four major parties including PML-N, PTI, PPP and PML-Q. One of the major points was that the economy desperately needs stronger actions, which will fix things in the short to medium run. Meanwhile, in the long run certain reforms are needed for the stabilisation of the growth process.

Investment, which is crucial for growth, is being constrained by terrorism and energy shortages. Other constraints include lack of skilled labour and the high cost of doing business. For the removal of the constraints and dealing with other obstacles it is necessary to facilitate investment.

From the manifesto of each political party, all of them seek economic revival, and the PML-N suggested a good strategy for curbing of energy shortage, which is a topmost constraint in investment. The manifestos advocate formal and technical education, but the policies suggested were directionless. The cost of doing business can be reduced through provision of incentives. But this is not good for the economy because incentives in the form of tax holidays and tax exemptions can be abused by seekers of rent and revenue. Loopholes in the system are used by these elements because of weaknesses in our tax system, tax administration and excessive discretionary powers given to tax officials. Without any doubt, we need reforms in all departments concerned, including the ministry of commerce and industry, the FBR, and Smeda.

Before the elections, all parties, especially the PML-N, pledged that the energy crisis would be eradicated within two years. But they soon realised that the solution is not that simple. But those parties which came to power or share power are in the process of trying to make a strong energy policy. Meanwhile, the shortage of electricity has been mitigated and some other projects will ensure continuous electricity supply for the next 10-13 years.

As for policies on eradication of terrorism set out in the parties’ manifestoes, in each case they were only vaguely discussed, with none of the document clearly indicating the root cause of terrorism, or suggesting a viable solution to the problem. Therefore, despite the fact that terrorism is under the government’s consideration since the formation of the new governments, no workable policy is in place yet. The APC discussed the issue and came up with the unanimous decision of talking to the Taliban. We avoided doing any kind of analysis before the talks started. Karachi, Pakistan’s business hub, has witness a large number of targeted killings for many months. The Rangers are deployed and their charge has been given to the Chief Minister of Sindh, but whether this will benefit the economic situation in Karachi is a big question mark.

The budget was the first major policy of the government after they took charge. Could we leave budget-making to the bureaucracy and its team of accountants? Budget-making is not an exercise in accountancy. The first budget was brutally criticised by analysts since everyone was expecting some relief resulting from it. The budget is supportive of economic revival since the government gave some exemptions to the industries. The budget deficit is huge and we need more revenues to overcome problems of piling public debt. More taxes on the salaried class and the one percent increase in GST created havoc for the government, and afterwards the increase in taxes on prepaid cards had a devastating effect, especially on the social media, even though the tax on prepaid cards is a progressive tax.

I put some question to people belonging to the educated working class. Almost everyone said he or she believed that the PML-N has not clearly spelled out the direction the party intends to take. The government is in the process of making “Vision 2025,” which has some new points that were absent in “Vision 2030.” The think tanks and the Planning Commission are working on “Vision 2025.” which will elucidate the main points of the policies and plan of action for achievement of the vision.

Due to the circular debt payment and other measures taken by the government, the duration of load-shedding has come by a significant number of hours. On the performance of the current government the respondents were clueless about what the government actually wanted to do. They said that the policies of the government are directionless. This is because the Prime Minister did not mention the policies his government will adopt during the next five years. He should have taken the nation into confidence on the current situation and the policies the government is going to implement. In the first three months of the government, most people have faith that the policies of economic revival, the energy policy and development of better relations with India will have positive long-term outcomes on the economy.

In order to get an idea of how people perceive the performance of the current government everyone was asked to rank the performance on a scale of 0 to 10, with zero implying the worst and 10 implying the best. The average score is 4.3, which is below average. This implies that even though load-shedding has mitigated and some other policy measures are taken, the performance is not satisfactory.

From their speeches made at rallies before the elections, people were expecting that things will change overnight and some of the old ministers will be imprisoned by the new government, but these did not happen. This kind of expectations are too emotional. Moreover, expectation of a pro-poor budget wasn’t unconventional but the budget was definitely not pro-poor. Corruption eradication, police reforms, judiciary reforms, civil bureaucracy reforms and tax reforms were among the top priorities of the educated class which are not addressed by the current government and there is a hunch that they might take some measures to eradicate corruption. However, they are not in a mood to work on reforms to make the overall system better so that it facilitates the common man.

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Free Trade-Unemployment-Terrorism

World is pro free trade but it is not beneficial for everyone. Some will be gainers and some will be losers. The gainers will compensate the losers. But How...? Under WTO safety nets program is designed to distribute resources among losers after getting from gainers. Who will do it...? Are we looking towards the government who is very inefficient due to high transaction cost including corruption and high maintained status quo and hierarchy? In the corruption index we are among the list of corrupt countries, though improved in the last few years.

This is one problem which we might face under free trade. Another problem is that the losers will lose the job as well as money. If they get do not get required amount of money to live their standard life they’ll be deprived off what they were having without free trade. Moreover, we are ignoring the component of satisfaction here. A person who was previously working is either unemployed or working at some place where he does not want to work. In other words his job satisfaction is zero compare to his/her previous job, hence the overall satisfaction. If the person remains unemployed for a longer period of time he thinks of many different thing including shake hands with the extremist element, become a thief or a dacoit. Thus unemployment is definitely a social evil which is very high right now in our country.

From the above can we conclude that unemployment or dissatisfaction from employment could be a big cause of terrorism? After all this do we need blind eye free trade or we need to see pros and cons of free trade for our own country, first solve those issues and then pursue for free trade. 

P.S. During the last one decade of low growth and higher unemployment, inequality has increased. Moreover, unfortunately frustration has increased which leads to intolerance. Unemployment and several other factors has increased the possibilities of terrorits activities

The case for data indices

This article in published in the "money matters" on 16 Sep 2013...

The analysis of an event requires the use of logical facts that are based on observational features. That is the art of conducting an effective analysis. Meanwhile, it can also be based on data.  Data helps reveal accurate and logical results. Hence, it plays a crucial role in analysis. Different data sets are available for different countries in the world that have their own definitions and adjustment factors. For instance, the GDP data obtained from Pakistani sources will differ from that obtained from World Bank and IMF publications or the CIA Factbook. Although international sources obtain data from Pakistani sources, it is then changed based on their own definitions.

Besides data obtained from local sources, international organisations are also involved in collecting primary data. Transparency International and Global Competitiveness Index draw data from an opinion survey that is designed by them. On the other hand, some international sources obtain data from various local sources, including national accounts, Pakistan Bureau of Statistics and non-governmental organisations such as Gallup. Subsequently, an index is compiled using the country data, which also helps to compare that particular indicator with other countries.

Due to the nature of different data sets, definitions of variables and dissimilarities in the classification of fiscal year for each country, the indices could be misleading and thus the reliability of data sets comes under question. The problem lies with all those data sets (human development index, failed state index, etc.) that use macro variables, such as per capita income. Similarly, Transparency International’s corruption data is a perception survey but is generally considered as actual data on corruption. Further, the International Country Risk Guide’s quality of governance data represents points assigned to different variables by respondents in different countries.

Chances of the respondents being biased in attributing scores for various indicators in different countries are significantly high.

Recently, the Walt Disney Company decided to cancel textile import orders worth $150 million with Pakistan due to the country’s inability to improve its position in the worldwide governance index (WGI).

The cancellation of import orders based on specific data that has nothing to do with the quality of products is a non-tariff barrier on the textile sector by Walt Disney. It is anticipated that other firms will soon follow suit, which could cost the country more than $1 billion exports.

The WGI compiles aggregate and individual governance indicators for 215 countries using six dimensions of governance (voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law and control of corruption) over the period 1996-2011. The index value for each of the six governance indicators varies between -2.5 and 2.5 (from worst to the best). Various data sources, including the Economic Intelligence Unit, Afrobarometer, etc., are used to develop these indices. More than 20 sources are used to construct each variable index and then the six variables are combined to construct the WGI.

While the data provides an insight into the overall performance for the last many years, it also portrays an astonishing economic picture. For example, the variables ‘political stability’ and ‘absence of violence’ have only two dimensions, i.e. political stability and absence of violence. In the last era of democratic government we had political stability but violence in terms of drone attacks and suicide attacks had increased. Thus respondents could give biased opinion if both the questions are asked together.

The data on political stability and absence of violence reveals that there was more political stability and lack of violence over the period of 1996-2000. Further, political instability and violence had risen from 2008 to 2011 as compared to the Musharraf/PML-Q era. Undoubtedly, drone attacks and acts of terrorism were more frequent during 2008-2011 but that era was the most politically stable. Nevertheless, the data tells us a different story, which raises questions about its authenticity.

Apart from voice and accountability, all the variables have shown deterioration in the last era of the PPP government. The WGI data might be misleading but it can be used effectively for the country.

All the six indicators show that the country’s position has remained below zero, which implies weak governance and the need to undertake strong measures to fix these issues. We need to stop seeking donors’ assistance and instead undertake soft reforms in different sectors, particularly civil service. Undertaking these reforms does not require heavy investment funds, rather strong will of the government and bureaucracy.

The cancellation of import orders by Walt Disney is a wake up call for the government. There is a possibility that Pakistan’s products could lose a substantial chunk of exports in future if companies look toward the WGI or any other indicator before entering into a trade agreement with the country. As the data represents the scenario till 2011, the question is how a well-established company could cancel a $150 million deal in 2013.

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Exchange rate economics

The article was published in the "Money Matters" on August 26, 2013

There are some possible solutions to stabilise exchange rate. First and foremost is the exchange rate forecast. Different fundamentals are considered to forecast it in the short, medium and long run. The demand and supply of foreign exchange reserves in Pakistan is the most vital determinant, which determines the value of exchange rate in the short run. Another key variable is the interest rate that helps to forecast exchange rate through two channels: impact through change in money supply in the long run and impact through change in capital inflows or outflows.

The possibility of the former channel is more likely to affect the country’s exchange rate in the long run. As there are capital controls in Pakistan; the latter channel may not be feasible in studying movements in the exchange rate. However, if expectations of price changes are included due to changes in money supply then interest rate might be a suitable determinant of exchange rate in the short run.

The relative price (difference between price in home and foreign country) is another important determinant of exchange rate. Technically, it is known as Purchasing Power Parity (PPP). If the exchange rate is adjusted according to changes in relative prices, the PPP holds.

However, due to State Bank of Pakistan (SBP) interventions, delayed response of price increase and speculators creating excess demand and supply of foreign exchange in the market to manipulate movements in the exchange rate, it is not receptive to price changes in the short run. But change in relative prices is an effective determinant of exchange rate in the long run.

In the wake of a balance of payments deficit, it is difficult to control exchange rate depreciation. Nevertheless, the country can do away with the need to borrow if it liberalises its capital account and the current account is financed by foreign direct investment and foreign portfolio investment, along with remittances (part of current account balance). Consequently, external debt will decline.

Due to increase in forex reserves, the exchange rate will be artificially controlled by foreign exchange injections in the market. Can this policy be supported? Judging from the Indian and South East Asian experience, it is a definite yes but with several reforms. A rule-based policy is needed to avoid time inconsistency. Further, the fiscal deficit should be reduced to decline the overall public debt as well as debt servicing.

Operational independence of the SBP is a key prerequisite to stabilise the exchange rate. The government should refrain from any policy intervention. For instance, the SBP should ask to maintain exchange rate within a certain band with specific interventions in the market. Similarly, targets should be set according to expected changes in prices in a particular year, expected trade balance and expected changes in forex reserves position. This would help boost the confidence of domestic as well as foreign investors. This policy would not favour rent seekers.

Monetary stability is necessary to reduce inflation and maintain exchange rate stability. However, this is not possible in the presence of a huge fiscal deficit as the government seeks funds from the central bank or scheduled banks with regular intervals. This causes inflation in the economy, thus contributing to exchange rate depreciation in the long run. In the short run, it overvalues the real exchange rate and makes exports expensive globally. Ultimately, this causes a decline in exports and trade balance, which has a directly impact on exchange rate.

Despite mitigating the current account deficit, remittances are still not among the most favoured policies to curb the deficit. Exports and imports are the two main components of current account. A cut down in imports resolves the problem but what kind of imports and how is the main question of concern? Reducing imports of capital and intermediate goods is not beneficial for the production sector. On the other hand, the end consumer is worse off if imports of consumerable items are reduced.

Another option is to increase exports by increasing production, discovering new potential markets and signing preferential and/or free trade agreements. Is this possible? For the last many years, several export-oriented policies have been adopted. Have those policies, by any means, had a positive impact on the trade balance. The answer to this is a no, as is evident from the situation of trade balance.

In conclusion, there is a fundamental solution to all the problems and that is the growth of the economy. For growth, exchange rate stability is not required. Slight volatility may help the economy to grow faster but higher volatility may dampen growth. Volatility is not the major issue in Pakistan.

Investment – private domestic investment or foreign investment – is required for growth. Reforms are needed to attract investors to the country. The framework of economic growth (FEG) is among the better policy options for the government to move on to the path of growth.

However, researchers have criticised the FEG as no timeframe has been provided in the document. Further, it will probably take 30 to 50 years to implement the FEG’s policies.

Hence, there is a need for short term policy measures to overcome the anomalies in the path of long run growth.

Finally, a few research questions that will further increase the understanding of exchange rate economics of Pakistan: do we need to control exchange rate? What if we have free float exchange rate systems with limited SBP interventions or no interventions at all? As volatility is not a problem for the economy, can we handle the trivial volatility patches in exchange rate? The writer is a research economist at PIDE 

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