Down inflation road, again By Khurram Husain

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THIS is not the first time we are seeing growth with inflation in our country. We have been down this road before, and it is worth our while to recall what key lesson needs to be learned from our previous experience.

Back in 2003, inflation had begun to rise and in the years that followed it spiralled to reach historic proportions. Then, as now, the government first tried to spin it away, then tried to argue that it is due to ‘supply-side’ pressures like rising oil and wheat prices in international markets, and eventually the State Bank governor even tried arguing that inflation is not so bad a thing after all so long as it is accompanied by growth.

But more detailed research into the subject came to a different conclusion. To take one example, a paper published in 2006 by Mohsin Khan, an IMF staffer who later served as mission chief for Pakistan, found that “monetary factors have played a dominant role in recent inflation, affecting inflation with a lag of about one year”. Space considerations prevent a more detailed discussion of the data and methods used by Khan, but enough to say that other papers written at the same time all came to the same conclusion, that the prevailing inflation in Pakistan was due more to monetary factors, meaning an excess amount of money creation, rather than supply-side factors like temporary shortages or global price increases in fuel.

Contrary to the government’s spin at the time, what was fuelling inflation in reality was excess money creation, which was deliberately engineered to produce short-run economic growth. The then State Bank governor Ishrat Husain admitted as much to me during an interview I recorded with him a few years later.

Is it possible that once again a closer look will show that monetary factors are behind this growth and inflation?

Today, the same debate seems to be playing out all over again. We have growth with inflation, and the government first touted its growth miracle earlier in the year, and is now blaming supply-side factors to argue that the inflation is not its fault, and certainly not in its control. But is it possible that once again a closer look will show that monetary factors are behind this growth and inflation?

One key number to start with is what economists call ‘broad money’ which consists largely of cash in circulation and total deposits of the banking system (among a few other smaller heads). The State Bank began reporting large increases in broad money even before the Covid stimulus began, but never flagged it for its inflationary potential. Broad money began growing in early FY20, and has risen stupendously since then. In the early months of FY20, it rose mainly on account of foreign inflows, but by the third quarter of the year — running from January to March 2020 — it spiked due to domestic factors.

“The expansion in money supply more than doubled during Q3-FY20 over the same period last year,” the State Bank wrote in its third quarterly report for FY20. “On a cumulative basis, [broad money] expansion during Jul-Mar FY20 stood at Rs1.5 trillion compared to Rs812.9 billion last year.” March was a turning point that year because that is when the Covid lockdowns began. People withdrew cash from banks to keep at home and foreign investors who had entered in large numbers into Pakistani debt all exited. All the movements in the country’s monetary aggregates reversed themselves, and the feeling at the time was that this is all temporary.

But it proved to not be temporary. The cash to bank deposit ratio rose to a 20-year high by June 2020, crossing 42 per cent, “a level last seen in FY92” the State Bank said in its annual report for that year. To this day, this ratio remains above this level. Broad money growth, far from slowing, rose by 7.8pc next year too, where “average broad money growth stood at 5.5pc during July-March in FY15-19” according to the third quarterly report of FY21.

Increase in the money supply sends cascading effects through the economy that ultimately impact prices. As the money supply grows, without corresponding increases in the economy’s ability to productively utilise this money, it spurs consumption and produces a short-lived ‘feel-good’ factor, places pressure on the exchange rate (since you have more rupees chasing fewer dollars), and if it accumulates in the form of large cash hordes, can also give rise to speculative pressures that pile up on asset prices from stocks to property, or more perniciously, in speculative hoarding of non-perishable food items.

This has happened once before in our history. In the heyday of the Musharraf growth rates, money supply increases produced a short-lived growth spurt but lit an inflationary fire that started in 2003 and turned into an inferno by 2008. Along the way, the State Bank failed to squarely point out the root causes of the inflation, leaving that job to independent researchers, who were not able to put their thoughts on record until 2006, by when we were too far down inflation road. This gave the government the space to more or less gaslight the country on the causes of the inflation, first claiming it is short lived, then claiming it is temporary, then claiming it is due to supply-side pressures beyond their control.

It is critical to not repeat history. Today, there is a dire need for independent researchers to step forward once again, and tell us whether or not the large money supply growth of the recent past lies behind the rising inflationary tide engulfing the country. This government has administered a stimulus more massive than the economy could productively use in the name of saving the economy from Covid. For a while, it worked and they were able to claim success in reviving growth. But now comes the time to pay the bill. And where the fruits of the growth were appropriated by the wealthy, the bills will be paid by the poor in the form of runaway inflation.

The writer is a business and economy journalist.

khurram.husain@gmail.com

Twitter: @khurramhusain

Published in Dawn, November 11th, 2021

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