DOUBLE DIGIT INFLATION TO PERSIST NEXT 6-MTH

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July 19 - 25, 2010

The persistence of double digit inflation over the next six months is inevitable due to planned increase in energy prices and food inflation which is higher than global prices as well as fast ensuing Ramzan factor.

The rupee dollar parity which is over Rs85 a dollar is one of the major factors pushing up fuel prices igniting inflationary pressure in the country. To strengthen the rupee calls for further strengthening of foreign exchange reserves which are currently estimated at $16.767 billion, which is largely borrowed from international donor agencies.

This makes generation of foreign exchange through domestic resources imperative in order to get real benefit of the reserve strength as well as to normalise the exchange rate, sources said.

The double digit inflation according to Year on Year Consumer Price Index (CPI) has now spanned over a period of 30 months. Historically, inflation has been led by fiscal lapses and delayed policy response and exacerbated by food and energy prices.

The financial experts however are of the opinion that inflation cycle is likely to return to average eight percent provided exchange returns to normalcy and inflation should come to moderate. However, inflation moderation thesis remains at risk in the wake of weak harvest and crude oil prices.

According to the latest inflation statistics, YoY CPI for June 2010 was settled at 12.69 percent as against 13.1 percent in Jun-2009 while period average for financial year 2010 (Jul-Jun) has clocked 11.73 percent.

The prominent contributing factors have been food, fuel and transport indices which are up 14.5 percent, 16.4 percent, and 15.8 percent, respectively. Interestingly, food group (40 percent of CPI) alone explained 45 percent of YoY increase in CPI. Core inflation on the other hand declined to 10.3 percent YoY as of Jun-2010 as compared to 15.49 percent over the corresponding period of last year.

In this regard, the current inflation cycle has not been different. Either delayed policy response to fiscal expansion and external imbalances ignited first round of inflation, followed by austerity measures on the front of energy sector.

In the near term persistence in inflation is inevitable due to structural drivers such as electricity tariffs (to be increased by 30 percent; higher GST/VAT and Ramazan factor. Over the medium term, the inflation cycle is likely to return to average i.e. eight percent in 2011 as high comparison base kicks in, exchange rate has normalised and with food prices already higher than global. However, even with conclusion of power tariff adjustment process, the commodity prices and domestic supply-chain are the factors in shaping headline inflation.

FINANCIAL INSTITUTION TO PLAY A GREATER ROLE

The central bank has suggested some important steps to improve role of the financial sector particularly the Development Financial Institutions (DFIs) to resolve the financing issues in the development of infrastructure in general and energy sector in particular. As at least seven percent of the GDP investment is imperative in infrastructure development if the economy has to attain a growth rate of seven percent.

Muhammad Kamran Shehzad, Deputy Governor, State Bank of Pakistan has called for private sector in the development of infrastructure in the country since public sector alone cannot fulfill the responsibility of removing infrastructure deficiency at the inauguration of a five-day Training Program on 'Frontiers in Infrastructure Finance' organised jointly by the State Bank of Pakistan and the World Bank at SBP last week.

He pointed out that the country's banking sector, together with DFIs, has an outstanding portfolio of Rs284 billion in overall infrastructure sector of which a staggering 68 percent is in power sector alone. Other key areas like oil & gas exploration, petroleum and roads etc. are not getting much financing and the performance of DFIs is very disappointing, with only 2 percent share in overall portfolio.

He said the present scenario called for some concrete steps towards infrastructure development.

Kamran said that the importance of private sector is extremely critical for success of any policy initiative in the way of infrastructure development. He said that currently the role of private sector is limited to the projects in energy sector in the form of Independent Power Producers (IPPs) and the success of energy sector in attracting private capital was due to a policy of the federal government which provided sovereign guarantees that led to opening up of avenues for the private sector.

Kamran said that SBP while recognising the pivotal role for private sector participation in the infrastructure development formed an infrastructure task force inviting participation from key public and private sector stakeholders. The task force was mandated to put their heads together and identify obstacles to development of infrastructure in general and infrastructure finance in particular and propose viable ways for effective private sector participation, he said and added that one of the principal recommendations of the task force was the establishment of a dedicated institution, which not only provides financing solutions but also develops infrastructure projects to attract private sector under Public Private Partnership (PPP) mode.