This divergent move can be attributed to the delay in passing on the price increase in wholesale prices to retail prices


Aug 23 - 29, 2004





Following the release of inflation figures for July 2004, a lot of hue and cry has been raised highlighting the fact that July has shown the highest monthly YoY inflation in the last 6 years, at least. However, some of the analysts feel that a certain aspect of inflation such as the relationship between Consumer Price Index (CPI) and Wholesale Price Index (WPI) and the fall in WPI inflation in July 2004 have been glossed over.

According to the data made public, CPI for July 2004 increased by 9.33% on a YoY basis. The main components contributing to a rise in inflation were food and beverages and house rent, which together account for about 64% weightage in the index. The fuel and lighting component was higher by 2.7% YoY. The muted increase in fuel prices is owing to the fact that the GoP has not changed the retail prices of POL products since May 2004. If international crude oil prices continue upward trend, it is likely that the GoP might be forced to increase POL prices. This increase would result in higher inflation making the full year target of 5% inflation slightly difficult to achieve. Despite these alarming signs, an interesting factor to note is the fall in WPI.

An interesting aspect of inflation is the relationship between the CPI and the WPI. The deeper probe shows that thrice in the last fiscal year, the CPI and WPI have moved in opposite directions. Of these instances, on two occasions, the WPI has been the leading indicator and CPI has followed the suit. However, in June as well as in July 2004 CPI and WPI have moved in entirely opposite directions. Some of the analysts believe that the 1% MoM fall of WPI means that CPI would also follow the suit although with a time lag. This lag is most likely due to the delay in passing on the price increase in wholesale prices to retail prices.

According to the figures released by the Federal Bureau of Statistics there has been a 9% YoY rise in headline and a 6% YoY rise in core inflation. Food remained the biggest inflation driver followed by house rent. Keeping in view the YoY rise in core inflation one would assume that the SBP would react by raising interest rates sharply. However, keeping in view of the statements of Governor of State Bank of Pakistan (SBP) and the GDP growth target fixed by the government, it is expected that the central bank will adhere to its policy of gradually raising interest rates.


Inflation during last financial year reached 4.57% level mainly due to higher food prices. The first month of current financial year is no different, with food prices recording a devastating 15% rise on a YoY basis. Like last year, house rent continued to contribute to higher inflation rate, recording 9% growth on a YoY basis. Fuel price hike remained constrained, rising by only 3% YoY, as the government continued to protect domestic consumers from rising international oil prices. Since May this year there has been successive reductions in the Petroleum Development Levy (PDL). It is believed that inflation rate will continue its upward trend during rest of the year. Any potential ease in food prices later in the year, due to wheat imports, is expected to be more than offset by rising POL prices. It is believed that the government would eventually have to pass on the impact of high international oil prices to local consumers. Furthermore, house rents are also expected to continue upward trend because of rising prices of real estate.




According to the various statements of the SBP Governor, while the central bank is maintaining its 5% inflation target for the current fiscal year, it may adjust this figure in accordance with market conditions. This is a bad situation for the SBP. On the one hand, core inflation, which is interest rate sensitive, has shot up by 6% YoY and is adding to the pressure being put on the rupee's value versus the US dollar. On the other hand a rapid interest rate rise could possibly damage Pakistan's economic growth and restrain it from attaining the 6.6% GDP growth target set for the current financial year.

According to an analyst one should not distracted by the opposite movement of the CPI and the WPI for the simple reason that both are based of different baskets. Only apples can be compared with apples and any attempt to compare apples with oranges is a futile and misleading efforts. If there is any inverse relationship, it is only due to time lag. He was also of the view that the government could not maintain May 2004 prices of POL products because it would lead to higher borrowing to meet the fiscal deficit. International prices of crude oil are not expected to ease despite constant increase in output by the OPEC members. However, the central bank should redefine its policies regarding financing of commodities trade. It is understood that taking the advantage of low rates and easy financing some of the traders are indulging in unethical practices.