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Policy rate, inflation and taxation

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Petrol prices are directly correlated to inflation

TPakistan saw the highest rise in policy rate in 2018 in Asia; yet inflation has not been dented. While, in order to rein in aggregate demand, in turn as a tool to curb rising inflation, the State Bank of Pakistan (SBP) increased the policy rate during January-March 2018/19 by 4.25 per cent to 10.25 per cent, yet at the same time CPI (Consumer Price Index) inflation (or simply inflation) could only fall slightly for a few months in between this time period, and rather as a whole there was a positive increase of 5 per cent. Even during the tenure of the current government, that is September-March 2018/19, the same consequence was seen, whereby while rate was increased by 2.75 per cent, inflation rate could not be brought down as a whole, which increased by 4.3 per cent.

Further analysis indicates that the policy rate was successively increased five times in just ten months, that is, from 6.5 per cent in May 2018 to 10.25 per cent in March 2019. Having said, during all those ten months, inflation only decreased for three months and that too by a paltry 1.3 per cent combined; increasing, in turn, during this time from 4.2 per cent to 9.2 per cent. Still the SBP has pursued monetary tightening- and government has not objected to this policy– whereby it increased policy rate by a half-a percentage-point in one go to 10.75 per cent. How can the authorities persist with monetary tightening, is beyond comprehension. One wonders how much persistence with this policy contributed to downward projections of economic growth; not to mention the dampening effect it will have on the government’s own declared objective of increasing employment levels in the country.

It is high time indeed that the government looks to fiscal policy measures and governance reforms, not to mention coming up with policy to reduce inflationary pressures from market failures in the real sector markets in particular, like agriculture and real estate, among others. As data amply shows, monetary policy is not working, and rather is denting investment levels and with it growth prospects. In its eight months, the performance of government is nothing more than paltry.

Overall, the SBP and the government should come up with better and more diversified planning in dealing with the big challenge of inflation

Another source of inflation, is the rising prices of petroleum products. Analysing the composition of price of E-10 Gasoline on the basis of data published by the regulator, OGRA (Oil and Gas Regulatory Authority)- a major component of overall oil demand in the country, since it is mainly used in running vehicles; reveals areas of possible correction in prices to reduce the overall inflation in the country.

Firstly, it could be seen that during January-March 2018/19, the trend of inflation followed approximately the changes in maximum ex-depot sale price of E-10 gasoline (or simply petrol). Hence, during May-July 2018 and then in March 2019, when the prices of petrol rose, the inflation rate also increased. Similarly, when the prices decreased during August-September 2018 and then in December 2018, the CPI inflation rate also either decreased or remained unchanged. This indicates the heavy bearing of changes in petrol prices on the overall inflation rate. Here, in some months, even when the price of petrol fell, as in April 2018, or January-February 2019, the rate of increase in inflation was very low; not more than one percentage point. Given this, therefore it is very important that the government, rather than just relying mostly on monetary policy to control inflation, should have explored ways to keep the prices of petrol low, since as seen they have a strong impact on the inflationary pressures in the country.

Since, the exchange rate will take time to come down, at the back of primarily improvement in institutional quality to enhance exports, the other main source of keeping the prices of petrol lower could have been reducing the burden of taxation that the retail price of petrol carries. Once again, analysis of E-10 Gasoline (or petrol) prices reveals interesting aspects in this regard.

Two taxes are mainly imposed on the prescribed price of petrol, petroleum levy and GST, where the prescribed price is also inclusive of dealers’ commission, and when combined with inland freight margin, leads to the maximum ex-depot sale price (or simply sale price). Here, with regard to the proportion of taxes in the sale price, it could be seen that the average proportion of petroleum levy and GST combined in the sale price of petrol stood on average at 24.6 per cent during January-August 2018. Although the Finance Minister indicates that the burden of taxes has been reduced in recent months in petrol prices؎ with petroleum levy being zero for November 2018– yet the difference in the proportion of these taxes is not much; during September-April 2018/19, the average proportion of petroleum levy and GST combined in the petrol sale price stood at 22.2 per cent.

Moreover, there also appears to be a strong positive correlation between the level of petroleum levy and GST combined, and the rate of inflation during January-April 2018/19 (the time period taken for analysis), so that when they are rising (or falling) on average, inflation is also increasing (or decreasing), respectively. What is more alarming is that the difference between the prescribed price of petrol and the sale price is kept roughly the same; mainly through the application of GST. This indicates that the government apparently has kept the same level of inflationary pressure- and in turn a burden on purchasing power of consumers, and which was on average Rs13.2 per litre during January-August 2018, and did not change much after the new government took office, as it stood at a little higher level of Rs13.8 per litre during September-April 2018/19.

So not much has changed in terms of government’s preference to earn revenue from these indirect sources of taxation; which are also otherwise highly inflationary, being part of the petrol sale price that feeds into inflationary pressures in many areas of economic activity. The government should therefore, seriously look to lower these taxes to the minimum, and rather shift to enhancing direct taxes to fill this tax loss and in enhancing the overall tax revenue.

Overall, the SBP and the government should come up with better and more diversified planning in dealing with the big challenge of inflation; although the fact that this policy approach has not been adopted– and monetary policy has been over-relied on– has left a lot to be asked for from the authorities. This policy sleepwalk should end immediately, so that the plight of the masses from this high inflation could be relieved. At the same time, price and in turn taxation corrections, along with better governance of markets, should also take place in other important sectors with regard to inflationary build-up- like the energy sector prices.


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