Monday, January 3, 2011

Inching towards hyperinflation?

Inching towards hyperinflation?
A worried and agitated Dr Hafeez Pasha has warned about the consequences of the out of control government expenditures, coupled with the lack of effort to raise revenues. Speaking at the 26th annual general meeting of the Pakistan Institute of Development Economics (PIDE) on 29th December, 2010, he fired certain warning shots by highlighting the close link between printing excessive currency notes, due to the mounting fiscal deficit, that could over time lead to hyperinflation.

There was hardly any doubt that if the country failed to improve the tax-to-GDP ratio on account of the disparity in the taxation system and the stalemate in the provincial and federal governments' outlook for the responsibility to improve revenue collection, it would result in forcing the State Bank of Pakistan to print currency notes in hundreds of billions. The refusal of the SBP to the sovereign to do so could result in a government shutdown. And, the ongoing battle of the monetary authorities to fight the deeply entrenched inflation, over time, could result in a triple-digit rise in prices, ie hyperinflation.
During the ongoing year, the country is expected to witness an unprecedented budget deficit of over Rs 1.2 trillion. To meet this deficit, the government may be required to print Rs 1 trillion currency notes. Inflation caused by the printing of new notes of this magnitude would be so high that the people would forget about the inflationary impact of the RGST.

Talking about the skills of the economic managers of the country, Hafeez Pasha lamented that they had failed to bring the stakeholders and the political leadership across the aisle, to see the positive impact of the dire need for revenue generation. An equitable tax system, coupled with a provincial effort to enforce the agricultural income tax within the existing withholding tax law, without amending the constitution is the need of the hour.

It is unfortunate that the flood surcharge got muddled with the RGST and a political turmoil, starting with opposition to both taxes, has now turned into a threat of the break-up of the coalition government. Even at a technical level, there was still no unanimity or consensus on various aspects of the RGST. The PIDE was asked to compile a report on the inflationary impact of this levy, but it has not been completed so far. It was suggested that collection of the GST should go to the divisible pool from where it should be distributed according to the NFC formula among the provinces. Pasha also advised the IMF to be patient because the Parliament had to be given due respect and, as such, it was not possible to give a precise date for the introduction of the RGST. A VAT expert, Ehtisham Ahmad stated that the RGST was not a new tax and the problems associated with the GST of 1990 were sought to be fixed through RGST. We are at a loss to comprehend that both the fiscal experts (Dr Pasha and Dr Ahmad) do not hold the view that the starting point for a Value Added Tax (VAT) has to be at the retail stage. Are we not heading the wrong way? Having a threshold of Rs 7.5 million as an exemption limit will force manufacturers to absorb the full impact of the RGST (15%) on output, against the raw materials received from the exempt suppliers. The taxpaying corporate sector will wholeheartedly support the RGST if the threshold limit is removed in its entirety. At the same time, we feel that Pasha has done a great service by giving a timely warning to all stakeholders in the country, including the government, opposition parties and people in general, about trivialising a matter, which could assume very serious proportions in the near future.

The Federal Information Minister Kaira announced, on the same day, Cabinet approval of a railway rehabilitation plan, which shows ministerial ignorance to see the close relationship between the two variables. It is no secret that hyperinflation is almost inevitable if the Federal Cabinet persists in forcing the SBP to print notes for the rehabilitation of the Railways. Next will be Pepco; Pakistan Steel; PIA etc! At some point in time, the government could be tempted to unload the circular debt, amounting to hundreds of billions of rupees, through this easy but disastrous mechanism.

In our view, this is probably the most urgent and pertinent topic at this point in time, which needs to be discussed thoroughly at all levels to come up with the right solutions. The irony is that some political parties seem to be concerned about the inflationary impact of the RGST and are not seriously arguing the case for improving public finances of the country through the imposition of the RGST or other measures, like the removal of exemptions or cutting of current expenditures in order to reduce the need of printing currency notes to soften inflationary pressures on the economy. It is sad that ordinary people don't know the linkages because of lack of proper education and are easily hoodwinked when only one side of the picture is presented. Also, the gravity of excessive currency printing is not properly realised because, fortunately, Pakistan has never experienced the phenomenon of hyperinflation in the past. This is a time when people have to buy ordinary items of daily use with a sack full of currency notes whose value is declining by the hour and economic activity in the country comes to a standstill because of the general state of uncertainty. We don't want to frighten the people unnecessarily but the consequences of irresponsible fiscal mismanagement should be obvious to everybody. The negative impact of this flawed policy could be minimised to a certain extent if the country was experiencing a very high growth rate or the level of foreign exchange reserves was high enough to resort to heavy imports to cushion the impact of excessive demand conditions but no such luxury is available to the country at this point of time. As it is, it is difficult to fight deeply entrenched inflationary expectations but once the genii of hyperinflation is out of the bottle, it is very difficult to push it back to its old place because of the instilling of inflationary expectations in the psyche of the people in general and entrepreneurs and investors, in particular. Keeping the overall situation in view, we would advise the government and the opposition parties not to be swayed by political expediency but be guided purely by economic imperatives at this point of time. The RGST alone may not be the best option but a way can certainly be found by adopting other tax measures, reducing wasteful expenditures and exempting more essential items from the imposition of RGST in order to soften its inflationary impact on the poor people of the country. The goal should be the reduction of fiscal deficit and the printing of currency notes to a sustainable level and not to play politics at the expense of the health of the economy. We say this because hyperinflation would be highly damaging for the economy. The Governor, State Bank, Shahid Kardar has also admitted openly that economic managers have failed to convince the political leadership to impose the RGST. Dr Hafeez Pasha's frustration indicates that his student - Finance Minister Dr Hafeez Sheikh - appears to be struggling in his effort to reduce the budget deficit. Unfortunately, the political leadership in PPP-led coalition appears to be more involved in political issues and is paying no heed to its economic team pleadings.

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