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Explaining food inflation and food trade deficit

The Food and Agriculture Organisation’s Food Price Index (FFPI) is the most reliable indicator of movements in international commodity prices. Measured by this index, global food prices were up 33.9 per cent between July 2020 and June 2021, the length of Pakistan’s fiscal year 2019-20.

This fact should not be ignored while looking at the effect of imported inflation on food inflation in a country. The effect is bound to be higher if the country happens to be a net importer of food items. Unfortunately, Pakistan witnessed a huge food trade deficit of $3.954 billion in 2020-21 (between July 2020 and June 2021) up from just $817 million in 2019-20 and $1.061bn in 2018-19, a closer look at trade figures of Pakistan Bureau of Statistics (PBS) reveals.

Meanwhile, food inflation in Pakistan remained in double digits (13.6pc and 15.9pc in rural and urban areas respectively) in 2019-20 and (12.4pc in urban areas and 13.1pc in rural areas) in 2020-21. This high food inflation occurred due to several reasons. But high global food commodity prices obviously had a hand in it. Year-on-year food inflation in July, however, fell to 9.4pc and 7.3pc in urban and rural areas respectively.

While looking at food inflation it is important to consider two things: first, movement in FFPI and second, whether or not a country is running a food trade deficit. If FFPI is up and if the country’s food trade deficit is also large, then higher domestic food inflation becomes inevitable. Pakistan’s high food inflation is, thus, understandable.

Higher demand and increased cost of agriculture due to withdrawal of subsidies on energy and agricultural inputs plus some supply constraints have kept food inflation up and continue to do so

Domestically, however, several factors have affected food inflation. The PTI’s maiden federal government started signaling right from the beginning that it would incapacitate the 18th constitutional amendment. Provinces have full administrative control over agriculture through this very amendment. PTI’s signaling backfired particularly in Sindh which is the second-largest food-producing region after Punjab and where PPP is in power.

That, on top of the multiplicity of regulations prevailing across Pakistan for checking food prices administratively, made it harder to contain food inflation. Sugar and wheat crises partly rooted in politics and partly in mismanagement also aggravated the situation sending wheat flour and sugar prices to historic highs. Political considerations made it too difficult for an inexperienced federal and Punjab govern­­ment (working with a not-so-cooperative bureaucracy) to handle these crises on merits. And, lack of inter-provincial coordination worsened these crises.

This is the political aspect of high food inflation. If improvements are not made in this aspect food inflation may continue to give policymakers headaches even after easing of pressure on FFPI — and a possible reduction in food trade deficit during this fiscal year. The FFPI has eased somewhat in July compared to June this year but whether this trend will hold till June next year remains uncertain. Pakistan’s food trade deficit in this fiscal year can, however, be expected to shrink. (Wheat and sugar imports are estimated to remain lower in 20201-22 than in 2019-21, food exports to China are expected to rise after Beijing’s assurances of importing a million tonnes of Pakistani rice and exports of meat, fruits and veggies and seafood may grow).

The State Bank of Pakistan (SBP) had cut its key interest rate by 625 basis points between mid-March and the end of June 2020 to help the economy avoid a sharp recession due to the Covid-19 pandemic. It has kept the interest rate unchanged since then. This unusual easing of monetary policy helped in containing recession to just 0.5pc in 2019-20 and was also instrumental in achieving 3.9pc GDP growth in 2020-21.

But it also had a natural impact on demand-induced inflation.

Domestic demand, spurred up by monetary easing as well as the government’s fiscal stimulus package produced general inflationary pressures which also translated into high food inflation. Higher demand for food products — and increased cost of agriculture due to withdrawal of subsidies on energy and agricultural inputs plus some supply constraints have kept food inflation up and continue to do so.

Continuation of lax monetary policy also continues to fuel inflationary expectations and exaggerated electronic and social media reporting on inflation keeps fueling these expectations. Inflationary expectations create a self-fulfilling prophecy cycle prompting markets to behave accordingly while pricing their products and services. This monetary aspect of food inflation cannot be overlooked holding supply-side constraints as the only culprit.

The Covid-19 pandemic is far from over and continues to disrupt food supply chains across the globe. This means global food commodity prices may remain erratic between now and the end of 2021-22. Pakistan’s current account deficit has started rising once again and the rupee has started losing its worth against the US dollar. In 2020-21, the rupee had gained a little over 6pc against the dollar due to a reduction in the current deficit.

But in two months of this fiscal year, it has lost almost the entire gain made during the last fiscal year. The actual loss it suffered is 5.6pc, exchange rates data show.

This ongoing weakening of the rupee is sure to bring in another round of imported inflationary pressure including on essential food prices. In this situation, the food trade deficit needs to be cut down drastically. A nominal reduction will not work. Can the PTI government — still struggling to rein in the bureaucracy and unable to create inter-provincial harmony — slash the food trade deficit to manageable levels? Only time will tell.

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