Waqar Masood Khan
From October 2014 until March 2018, Pakistan faced a remarkably low inflation, averaging at less than 4%. This period of low inflation has finally ended.
Since March, there is an accelerating trend in inflation except in September, where it dipped a bit. The latest inflation number should be a cause for concern. In October, the year-on-year (yoy) inflation (versus October 2017) was registered at 7.0%, the highest in four years. Until recently, there were no signs of resurgence in inflation. However, almost all measures and independent forecasts are pointing to an unmistakable trend of a sustained resurgence of inflation. The average inflation during Jul-Oct was nearly 6%, significantly up from 5.6% during Jul-Sep.
That the inflation is following an aggressive trajectory is reflected in the month-on-month (mom) inflation, which rose 2.6% over September. The September inflation was lower because the oil prices increase was not passed on to consumers; in fact they were reduced by taking a hit in government revenues. Similarly, the numbers for the months of March, April, May, June, July and August, over their respective previous months, were 0.3%, 1.8%, 0.5%, 0.6%, 0.9%, and 0.2%, respectively. In the month of September, mom inflation was negative 0.1%. In both August and September, petroleum prices were either not changed or changed after taking a hit on government revenues. Clearly, a rising trend is visible in monthly inflation even if we normalize the exceptional increase of 1.8% for April and 2.6% for October. With these numbers, there should be no doubt that there is a sustained build-up of inflation. In fact, there are many other indications supporting the apprehension of evolving inflationary pressures.
To determine the contribution of various factors in this rising trend we consider its various categories. Food inflation was only 2.7% and its trend since March has been mixed. It is the non-food inflation that is the culprit, rising at 10% in October on yoy basis. Since January, it is increasing without a break. For mom also it is rising since September last year. Evidently, the food inflation, with its mixed trend, has been moderating the overall inflation. This fact essentially points to a deeper problem with inflation.
To examine the deeper problem, we need to look at another measure of inflation that isolates even the impact the of energy prices, often a source of high volatility in prices. For this, we look at what is called the ‘core inflation’. This measure removes the effects of such commodities whose prices are volatile both for seasonality or due to unpredictable behavior of international markets. These items include energy and food. This measure has shown unusual stubbornness as it has been rising, with few exceptions, uninterruptedly since October 2015. Fiscal 2015-16 was the year when inflation was the lowest in more than a decade and a half at 2.9%. Even at that time core inflation was 4.2%. In October, core inflation was recorded at 8.2%, highest in three years and coming to this level without a break. This also means that much of the low inflation period was driven by international oil price decline and good position of food crops.
But we would surmise that the inflation now in witness is a combination of delayed adjustment in administrative prices as well as the rising trend in international prices which have increased about 85% since late June 2017 but has come done somewhat more recently. The recent adjustment in gas, electricity and petroleum prices have significantly contributed to rising inflation.
Let us reflect on these factors and also assess the inflation outlook going forward. First, the international crude oil prices have risen by more than 85% since late June 2017. In late June 2017, from $46/bbl, Brent rose to nearly $85/bbl, before sliding back to less than $75bbl in more recent days, an increase of about 85%. Much of the increase was in anticipation of the impending sanctions on Iran, contributing nearly 2.8 million bpd in total supplies. Contrary to earlier threats from the US administration to completely dry out Iranian supplies and not exempt any country as in the past, it seems supplies would be cut by a 1 million bpd as 10 countries have been exempted from the ban, and that much the of reduced supply has been replaced by other oil producers together with a somewhat slowdown in world demand. Analysts are of the view that the Iranian risk has played out and the prices around $75 would continue in the near future.
Second, there is a great deal of policy related factors contributing to inflationary pressures. Even though a slow-down in aggregate demand is visible the required adjustment is far from complete. The recent adjustment in the exchange rate would have an impact on inflation, which has also not fully played out. The fiscal deficit remains high even though the data on fiscal operations for the first quarter has yet to be released. But the FBR performance is a source of concern as the growth in revenues has slumped below 8% during Jul-Oct, which was the growth rate in the previous two years. The impact of budgetary measures adopted in the mini-budget is not yet visible. The frequent decisions to cut taxes on petroleum prices, as noted above, is a major reason why FBR revenues are down.
Third, as we mentioned earlier, the administrative prices have not been fully adjusted and therefore there is a considerable degree of ‘stored inflation’ which would eventually be released. The gas price was adjusted only for about Rs.100 billion compared to the awarded amount of Rs.158 billion by OGRA. In the case of electricity also an adjustment totaling Rs.125 billion has been passed on while the rest has been hoped to be mobilized through recoveries of past overdues. It is highly unlikely that any of the two shortfalls would be met through additional revenues to be generated within the utilities. The NEPRA and OGRA determined prices, if not implemented, have to be provided through budgetary support, if not today then tomorrow.
It is obvious that the inflation outlook is quite grim. It becomes particularly significant in the backdrop of IMF program being negotiated these days. The fundamental premise of the program would be containment of aggregate demand primarily through fiscal correction. However, as we have pointed out, a great deal of price adjustment remains outstanding, which the Fund would undoubtedly press for either providing in the budget or passed on through increased prices. The IMF also sees policy rate significantly out of line with its market value for the simple reason that the government debt is financed by the central bank in an unrestrained fashion. To restore order in the debt market, significant adjustment in the policy rate is inevitable. The policy rate adjustment is also warranted on account of rising inflation. Reportedly, the Fund sees inflation rising to 14% by June 2019, which would call for a major adjustment in the policy rate.
Therefore, the inflation outlook, going forward, is not encouraging. A political government should be understandably concerned on inflationary pressures. However, there is no escape from making a one-off adjustment to clear the deck and then letting administered prices, the key factor affecting inflation, to reflect the true movements in their costs. Without this, a stable macroeconomic framework in the country would be absent and the economic crisis would continue to bedevil the policy makers.
(The writer is former finance secretary)