Dr Hafiz A Pasha
The people of Pakistan have been saved from the ravages of high inflation during the last four years. From 2014-15 onwards the rate of increase in the Consumer Price Index (CPI) has remained at or below 4.5%. In 2015-16 it even came down to below 3%. In particular, the extremely low inflation in food prices of less than 2% has cushioned low income families from falling below the poverty line.
There was one period earlier when the inflation rate came down also to below 4.5%. This happened from 1999-2000 to 2003-2014. At that time the average GDP growth rate was also relatively low at 4.2 %. The economy revived strongly in 2004-05 with a growth rate of 9% and the inflation rate also jumped up to over 9%.
Is Pakistan unique in experiencing low rates of inflation during the last four years? The answer is no. Within South Asia, the inflation rate in India and Sri Lanka since 2014 has also been significantly below 4.5%, at 4.3% and 4.0%, respectively.
Therefore, the explanations for low rates of inflation go beyond country-specific factors and are also be to found in favorable global developments. The objective of this article is to determine the relative importance of different factors in bringing down the rate of inflation in the Pakistani context.
However, we need to assess first if the rate of inflation in the CPI and other price indices is measured without any downward bias by the Pakistan Bureau of Statistics (PBS). Unfortunately, this is not the case as described below.
First, the consumption expenditure with the highest weight of 22% is housing rent. According to PBS, it has increased annually by 6% during the last four years. However, the Household Integrated Economic Surveys (HIES) by PBS reveal that the rate of inflation in housing rents from 2011-12 to 2015-16 was as high as 11%. This is not surprising given the large and growing shortage of housing in the country. The proper estimation of the index of housing rent in the CPI will raise the overall rate of inflation annually by 1.1 percentage points over the last four years.
Second, the base year of the CPI is ten years ago, 2007-08. There should have been an updating of the base year as consumption patterns have changed significantly. The share of consumption expenditure on food has declined from over 44% in 2007-08 to 37% in 2015-16. Since inflation in food prices has been much lower in the last four years, updating the price index will lead to a higher estimate of the rate of inflation by 0.3 percentage points.
Therefore, the rate of inflation annually from June 2014 to March 2018 is significantly understated at 3.8%. It is actually closer to 5%. This is still lower than the long-term rate of inflation of over 7.5% in Pakistan.
We focus now on the impact of international developments. The major factor is the movement of commodity prices since June 2014. By June 2017, these prices had fallen cumulatively by as much as 38%. In particular, oil prices have declined precipitously by 56%. This has been partly reflected in lower prices domestically of HSD oil by 30% and of motor spirit by 33%. This ought to have contributed to lower transport costs of goods, implying less ‘cost-push’ inflation.
A major reason for less inflation is the consequence of domestic policy related to the exchange rate. The rupee has been, more or less, nominally stable since June 2014. This has also implied less imported inflation. It is estimated that with a 10% increase in imported prices, the domestic price level rises by 3%. Therefore, the policy of fixing the exchange rate has contributed to a larger trade deficit but it has implied less inflation in the country.
There are grounds for believing that the stabilization efforts during the tenure of the IMF program have also contributed to lower inflation. Contractionary fiscal and monetary policies during these years have implied lower aggregate demand and thereby to less ‘demand-pull’ inflation. It is a relief to see that even after the end of the Program in September 2016, the rate of inflation has remained close to 4%.
There is need to understand the role of some special factors more recently. The inflation rate was 3.2% in March 2018. This is partly due to a ‘high base’ effect. The inflation rate last year in March was at the peak of 5%. It came down subsequently to 2.9% by July 2017. Therefore, the inflation rate could perk up from July 2018 onwards.
Further, the absence of any inflation on a year-to-year basis in food prices in March 2018 is partly attributable to the surplus stocks of wheat and sugar which have implied reduction in prices of these two basic commodities. Also, vegetable prices are down sharply. They had attained a peak at this time last year.
There are reasons to believe, over and above the ‘high base’ effect, that the rate of inflation will start rising in coming months. First, the impact of recent depreciation of the rupee will begin to be fully reflected. Second, oil prices continue to be on an upward path. In the remaining two months of the present Government they may not be transmitted to higher retail prices of POL products. But thereafter it will become necessary to do so in order to protect tax revenues. Third, there has been large-scale ‘printing of money’ by the SBP of over Rs 1040 billion. This will hit domestic prices with some time lag. Fourth, the buildup of circular debt may necessitate levy of surcharge on electricity tariffs, thereby contributing to some ‘cost push’ inflation.
A powerful indicator of the underlying propensity towards higher inflation is the ‘core’ rate of inflation. It was relatively high at 5.8% on a year-to-year basis in March 2018. It has also shown a somewhat rising trend since January 2018, by almost 0.6 percentage points. This should have been taken into account in the fixation of the Policy Rate recently by the Monetary Policy Committee of the SBP.
Finally, there is need to recognize once again that the low rate of inflation during the last four years has insulated the poor and the middle class from a significant drop in living standards. This has been the result of favorable movement in international commodity prices and due to stabilization policies adopted by the Government. There is need for continued efforts to keep the inflation rate at or below 5%.
(The writer is Professor Emeritus at BNU and
former Federal Minister)
