Daily Times

Pakistani policymakers, embroiled in Machiavellian plots, have missed out on a very important development: inflation in Pakistan has become public enemy no.1. Unchecked, runaway inflation, more than anything else, has become an existential threat for Pakistan. It can lead to the total and utter implosion of our social fabric and political system.

The massive inflation in Germany during and after WWI is a very interesting case in point, especially for those presently concerned by runaway inflation in this country. As Germany entered WWI in 1914, the core group of German policymakers, the men around the Kaiser, were convinced that they were facing a brief and victorious military campaign. As a result, Germany raised barely 10 percent of the massive $ 47 billion it ended up spending on the war. Instead, Germany relied on inflationary finance — printing money — throughout the war. Where money supply doubled and tripled in Great Britain and France during WWI, its increase in Germany was fourfold!

Even after WWI, printing money continued unabated in Germany in order to cover the fiscal gap that arose, in part, due to huge reparations — money that Germany owed to the victors of WWI. This deluge of money issued by the Reichsbank, the German Central Bank, resulted in massive internal inflation and currency devaluation. At the beginning of 1914, you could get 4.2 German marks for one US dollar. In 1920, however, the exchange rate had depreciated to 65 marks to one dollar. During this time, the general price level increased over nine times.

A series of events in 1921 including the French inflexibility over the demand for reparations from Germany and a campaign of political murders by right-wingers shattered the public confidence in the ability of German policymakers to turn around the economic crisis. Foreigners, even Germans, frantically began ditching German marks for whatever foreign currency they could muster. Even as the exchange rate plummeted, the German government kept printing money to cover its recurring fiscal deficits. Panic set in.

By 1923, inflation had acquired a momentum of its own. In August 1923, one dollar was worth 620,000 marks. And in early November 1923, a dollar was worth 630 billion (yes, billion) marks. In the last three weeks of October of the same year, prices rose one thousand times! Basic necessities now cost billions of marks in Germany: a kilogram of butter cost 250 billion and a ride on a Berlin street car 15 billion — it used to cost one mark before WWI. Almost worthless, currency notes were often used as wallpaper and stacks of currency doubled as children’s toys!

Inflation, more than any revolution, transformed the German social structure. Middle-class salaried people like civil servants, teachers, professors and doctors were destroyed as their lifetime’s worth of savings evaporated, almost overnight. Ex-generals in the Kaiser’s army took up jobs as bank clerks, teachers and professors started begging and women from respectable families ‘took to the streets’.

For the past five fiscal years, from 2007-08 through 2010-11, the official average inflation in Pakistan has been close to 14 percent, with 2008-09 peaking at 21 percent. The most recent data from the State Bank of Pakistan (SBP) shows that since 2007-08, the base year, prices have increased by 63 percent through February 2011. Though these inflation rates are not in any way similar to the rates of catastrophic inflation in WWI Germany, the similarities in the causes and potential impact of such consistently high inflation merit more reflection.

Economists agree that one of the main reasons behind consistently high inflation in Pakistan is the inability of the government to narrow the fiscal gap — the difference between expenditures and receipts. As a matter of fact, the government, lacking political will, and the Federal Board of Revenue (FBR), lacking capacity, have been unable to increase receipts in the shape of taxes collected (the four year average federal taxes to gross domestic product (GDP) ratio is 9.7 percent). For 2010, the International Monetary Fund’s (IMF) Fiscal Monitor Database puts Pakistan only ahead of Afghanistan and behind Ethiopia, Nepal and others in terms of general government tax revenue.

As a result, from fiscal years 2007-08 through 2010-11, the average fiscal gap was 6.4 percent of GDP. In the most recent review of the Pakistani economy (Article IV, 2012), the IMF is forecasting a fiscal gap of seven percent of GDP (Rs 1.5 trillion) for fiscal year 2011-12, against a target of 4.7 percent! Government borrowing from the SBP — inflationary finance — has already increased by Rs 182.6 billion (February 2012) in the present fiscal year, against the government commitment to keep borrowing at zero. Such massive government borrowings from the SBP (printing money) in order to cover its fiscal gap have acted as one of the key drivers for inflation in the last five years.

(To be continued)

The writer has taught economics at Lahore University of Management Sciences and presently works for the development sector in Islamabad. He can be reached at aqdas.afzal@gmail.com