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Menace of inflation

There are growing fears that the rate of inflation for January 2020 would be the highest in last nine years in Pakistan. It would be much convenient for the economic managers to blame the extraneous factors for this hike. However, the results could cause serious issues in Pakistan-IMF relationship, as the Government of Pakistan may not succeed in meeting the targets agreed with the lender of last resort.

Reportedly, food inflation — reflecting pass-through of increases in international commodity prices, lagged impact of currency depreciation and a seasonal increase in certain commodities — remains key driver pushing headline number to a multi-year high. Although, weak economic activity and an improving external account position merit monetary easing, the central bank (scheduled to meet later this month) with its singular focus on inflation will not move the needle until it gets comfortable with the inflation outlook. The recent price trends coupled with upside risks to inflation outlook have further dampened early easing prospects. Moreover, the materialization of upside risks to inflation could delay easing cycle beyond 1HCY20.

Preliminary price trends for January 2020 suggest a significant jump in the headline inflation, with monthly reading likely to reach 9-year high of 13.60%YoY as against 12.63% YoY for December 2019 and 5.60%YoY for January 2019. The upward adjustments in quarterly housing rent and government administered fuel prices are other major drivers outside food basket. In this regard, the housing and utility index is expected to move up 0.91%MoM, driven by quarterly upward adjustment in housing rent and rising LPG prices. The impact of said adjustments will be partially offset by the downward revision in electricity tariffs (down 2.10%MoM) due to relatively lower adjustment on account of fuel costs for January 2020. The transport index is likely to increase 1.25%MoM primarily driven by hike in government administered fuel prices (up 2.02%MoM).

Market wise, Urban inflation is expected to surge to 12.76%YoY as compared to 12.01%YoY for December 2019 and 6.16%YoY in January 2019, while Rural inflation – with more weight of food items – is likely to jump to 14.88%YoY as compared to 13.58%YoY for December 2019 and 4.64%YoY for January 2019.

 

Upside risks to inflation could delay easing cycle beyond 1HCY20. Unlike past few months, the recent price increases in food group are relatively broad-based (flour, edible oil and pulses) and non-cyclical in nature. The discussion with multiple vendors of certain food items suggest the same. Consider pulses, the price increase was long due following the rupee depreciation. However the ample supply availability kept the prices in check. Recent jump in price is both due to 1) supply normalization which allowed importers to pass on the impact of depreciation and 2) rise in international prices of pulses. In edible oil case, the rising international raw material prices are driving the domestic price increase. The domestic manufacturers are gradually passing the incremental cost impact from rupee depreciation and rising international prices. Our discussion with industry players indicates this trend might continue in the short term, as the impact of recent price hike in international prices is yet to be passed on. The secular increase in food prices along with upcoming utility rate adjustments (i.e. gas & electricity) means that the headline inflation will likely remain elevated in the short-medium term.

Analysts project inflation to average at 12.17% YoY in 1HCY20. However, they assume full pass-on of gas price hike (29% as per OGRA’s recommendation, incorporated from February 2020 onwards). The government generally shelters lifeline consumers (consuming up to 50 units) from rate hikes.

Assuming the government spares lifeline consumers, 1HCY20 inflation forecast would come down by 25bps to 11.92%YoY. For electricity tariffs, the timing and scale of further adjustments are uncertain. Note that unlike FY19 the upcoming adjustments in electricity tariffs would not be on the extreme high side, as the capacity payment component seems to have been built well in the base tariffs. The same is also evident from 1QFY20 adjustment. Furthermore, ambitious fiscal targets – notwithstanding a recent downward revision in FBR’s FY20 revenue target by Rs265 billion – pose upside risk to inflation outlook, where under performance on revenue target would compel the authorities to take additional taxation measures. Although weak economic activity and an improving external account position merit some easing action, the Monetary Policy Committee of the central bank (scheduled to meet later this month) with its singular focus on inflation will not move the needle until it gets comfortable with the inflation outlook. The recent price trends coupled with upside risks to inflation outlook have further dampened early easing prospects, in our view. Moreover, the materialization of upside risks to inflation could delay easing cycle beyond 1HCY20.

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