Assessment of the Finance Bill 2024's Effect on Inflation

Introduction

Inflation, currently at a significant rate of 26% as per government data and 25.5% according to the World Bank, is one of the most pressing economic challenges facing Pakistan. The Finance Bill 2024 introduces several fiscal measures that are likely to have a profound impact on inflation. This analysis evaluates these measures to determine their potential effects on the inflationary environment in Pakistan.

Key Provisions of the Finance Bill 2024 Affecting Inflation

1. Increase in General Sales Tax (GST)

- Provision: The bill proposes an increase in the GST rate.

- Effect on Inflation: Raising GST directly impacts the prices of goods and services, leading to higher retail prices. This measure can exacerbate inflationary pressures as businesses pass on the higher tax burden to consumers.

2. Higher Import Duties

- Provision: The bill introduces higher import duties on non-essential goods.

- Effect on Inflation: Increased import duties make imported goods more expensive. Given Pakistan's reliance on imported goods, this can lead to higher prices for a wide range of products, contributing to overall inflation.

3. Increased Petroleum Levy

- Provision: The bill includes amendments to the Petroleum Products (Petroleum Levy) Ordinance, increasing the levy on petroleum products.

- Effect on Inflation: Higher levies on petroleum products will raise fuel prices. Since fuel is a critical input for transportation and production, increased fuel costs will ripple through the economy, raising the prices of goods and services and contributing to inflation.

4. Utility Price Hikes

- Provision: The bill accounts for substantial increases in electricity (+50%) and gas prices (+40%).

- Effect on Inflation: Increased utility prices directly impact household expenses and production costs for businesses. Higher energy costs will lead to increased prices for goods and services across the board, fueling inflation.

Mechanisms by Which the Finance Bill Fuels Inflation

1. Cost-Push Inflation

- Mechanism: The increased cost of production due to higher taxes, import duties, and utility prices leads businesses to raise prices to maintain profitability. This type of inflation occurs when the cost of inputs rises, causing an overall increase in prices.

- Impact: As businesses face higher operational costs, they pass these costs on to consumers, leading to higher prices for a wide range of goods and services.

2. Demand-Pull Inflation

- Mechanism: While the bill aims to increase government revenue, the reduced disposable income for consumers due to higher taxes and living costs may not lead to demand-pull inflation directly. However, if the government increases spending using the additional revenue, it could potentially increase demand in certain sectors, leading to higher prices.

- Impact: Any government spending that stimulates demand in an already constrained supply environment can exacerbate inflationary pressures.

3. Imported Inflation

- Mechanism: Higher import duties and a devalued currency (1 USD = 285 PKR) make imported goods more expensive. Since Pakistan imports a significant portion of its goods, this leads to higher prices domestically.

- Impact: Consumers and businesses face higher costs for imported goods, contributing to overall inflation.

Mitigating Measures in the Finance Bill

1. Targeted Subsidies

- Provision: The bill includes provisions for targeted subsidies for essential goods and vulnerable populations.

- Effect on Inflation: While targeted subsidies can provide relief to low-income households, their effectiveness in curbing inflation is limited. Subsidies can alleviate some financial pressure on consumers but do not address the underlying causes of inflation.

2. Incentives for Agricultural and SME Sectors

- Provision: Incentives for the agricultural sector and SMEs are included to boost productivity and growth.

- Effect on Inflation: Increased productivity in agriculture can help stabilize food prices, while support for SMEs can enhance supply chain efficiencies. However, the positive impact on inflation will depend on the scale and effectiveness of these incentives.

The Finance Bill 2024, through its measures to increase GST, import duties, petroleum levies, and utility prices, is likely to exacerbate inflationary pressures in Pakistan. These cost-push factors will directly contribute to higher prices for goods and services. While targeted subsidies and incentives for key sectors aim to mitigate some effects, they may not be sufficient to counterbalance the overall inflationary impact of the bill.

To effectively manage inflation, the government needs to complement the Finance Bill with policies aimed at improving supply chain efficiencies, increasing productivity, and stabilizing the currency. Addressing structural issues within the economy and ensuring efficient implementation of subsidies and incentives will be crucial in mitigating the inflationary impact of the Finance Bill 2024.