Economy in slumpflation

Cracks have started to appear on the external front with the continuation of economic recovery

Current account deficit (CAD) turned out to be around 4

7% of gross domestic product (GDP) during July-October 2021, which is attributed to a higher merchandise trade deficit

Import growth surpassed export growth with a higher margin

The import growth is also associated with the current recovery

In a developing economy, raw material and capital goods are imported along with food group items

Demand for all these categories is inelastic

Apart from these categories, the demand for luxury goods also increases with the continuation of economic recovery

Although there is merchandise export growth of 32% in the first four months of FY22, the growth does not generate the necessary foreign exchange reserves to finance imported goods

Analysts, journalists and media commentators are of the opinion that the government should follow an export-oriented strategy by following the examples of Japan, South Korea, Singapore and Taiwan

They even criticise that trade policy remains inclined towards imports for a long period

In order to promote exports, price mechanism should work efficiently

On this basis, the rupee needs to be devalued to achieve competitiveness in exports

In the context of developed economies, a flexible exchange rate regime works well and the intended objective of growth is achieved

In the last few years, proponents of price mechanism have voiced their opinion that export promotion is indispensable in Pakistan and have supported the devaluation of Pakistani rupee vis-a-vis dollar

On this basis, the State Bank of Pakistan (SBP) has adopted a flexible exchange rate regime since 2019 and the inter-bank rate has crossed 176

The proponents come up with the usual description that CAD has increased manifold in FY22, which has put pressure on the rupee

They insist that the price mechanism will take time to show its results so the process of reform should keep on going at a reasonable pace

On the contrary, a chunk of development economists and practitioners have a different perspective on developing an economy

They are of the opinion that exclusive focus on price mechanism may lead to unacceptable development outcomes, especially inequality of income and wealth

The heightened inequality leads to political instability and unrest

They further state that ignoring import substitution is an unwise strategy as these industries are a stepping stone for export promoting ones

For that matter, a managed exchange rate regime is advisable

Moreover, a state should play pivotal role in guiding and facilitating business firms to achieve profit-maximising objectives

Inflation rate is accelerating owing to bottlenecks faced by the economy

As far as headline inflation is concerned, it is hovering around 9%

However, food inflation has been in double digits since August 2019

This implies that the agriculture sector is not growing at a decent pace

Our agriculture sector is not producing the exportable surplus required to finance capital goods and raw material

Therefore, it is acting as a binding constraint on the industrial sector

Although the government imports the agricultural goods that are in short supply to ease supply constraints, this adds to the bourgeoning import bill

Similarly, the double-digit imported inflation is on the rise as the rupee is depreciating against the US dollar

Inflation remained in single digits from March 2020 to February 2021, which was the period of Covid-19 lockdown

Interest rates in advanced countries are brought to near zero as speculation in commodities, metals and crude oil has played an important role in jacking up their prices

In short, the economy is in slumpflation where output is slowly growing along with accelerated inflation

The market-based solution will worsen the ongoing situation and create further worries for policymakers

Let’s see how the economy evolves in coming months

The writer is the Assistant Professor of Economics at SDSB, Lahore University of Management Sciences (LUMS)   Published in The Express Tribune, December 6th, 2021

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Date:01-Jan-2022 Reference:View Original Link