Galloping inflation

Pakistan today is experiencing high and rising rate of inflation. This is the highest inflation after 1973-74 and 1974-75 when it rose to 30% and 27% respectively, in the aftermath of the quantum devaluation of the rupee from Rs 4.77 to Rs 11.00 per US$. The primary objective at that time was to divert sales from West Pakistan to the then East Pakistan to international markets.

The rate of inflation is also on the rising trend in most countries today following an upsurge in international commodity prices, especially of energy, after the commencement of the Russia-Ukraine war. Countries are also experiencing the lagged impact of expansionary monetary and fiscal policies after the spread of Covid-19.

However, Pakistan is witnessing relatively high inflation. Among the countries of Asia, it has the sixth highest rate of inflation. The three countries in the region with the highest rates of inflation are Lebanon, Syria, and Sri Lanka, with rates of inflation of 142%, 139% and 57%, respectively. India and Bangladesh are experiencing low inflation of 6% and 9%, respectively.

The galloping nature of inflation is amply demonstrated by the quarterly average rates of inflation in Pakistan in 2022, shown in Table 1.

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                                Table 1
            National Quarterly Rate of Inflation, 2022
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                                                             (%)
2022                   CPI      Food Prices     'Core' Inflation
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January - March        12.6         14.0                     9.1
April - June           16.2         20.0                    11.2
July - September       25.1         30.0                    15.0
October - December     25.0         34.7                    17.0
Average                19.7         24.7                    13.1
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Source: PBS
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The rise in the CPI in the first quarter of 2022 was a moderate 12.6%, which has gone up to 25% in the last quarter. The same quantum jump is observed in food prices and the ‘core’ rate of inflation.

Prices of food items have risen by as much as 34.7% in the fourth quarter as compared to 14% in the first quarter. Clearly, inflation is hitting more the lower income groups. The average ‘core’ rate of inflation in the fourth quarter was 17%. This raises the likelihood of a further increase by the SBP (State Bank of Pakistan) in the policy rate.

There is need to understand the cause of the successively higher quarterly rate of inflation. First, this is the outcome of the continuing process of depreciation of the rupee throughout 2022 of 28%. Second, the supply shortages that have emerged after the floods in basic food items are affecting prices more now, especially since imports have also been cut back more in recent months.

The contribution of different items to inflation in December 2022 confirms the role of both supply shortages and imported inflation, due especially to the devaluation of the rupee. The supply shortage is manifest in the unbelievably high increase in the prices of domestically produced food items. The price of onions, for example, has gone up by an unbelievable 414%.

Similarly, the prices of wheat flour, rice, chicken, eggs, and pulses have risen by 41%, 47%, 44%, 54% and 41%, respectively. Overall, the contribution of food items to inflation is 41%, when the average share of these items in total household consumption expenditure is 31%.

Despite the high on-going rate of inflation, there is evidence that it is still understated. The prime example is of housing rent, which is shown as having risen by only 5% on a year-to-year basis. This is highly unlikely given that construction inputs’ prices have risen by 31% and wages of construction workers by 14%. The likelihood is that rents have gone up by at least 15%. This will add 2 percentage points to the overall rate of inflation of 24.5% in December.

What are the causes of the high inflation? The BNU Macroeconomic Model enables quantification of the impact of different factors, as follows:

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Rate of Monetary Expansion minus GDP growth      31%
Rise in Import Prices                            42%
Inflationary Expectations                        27%
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The impact of imported inflation is very visible. International commodity prices were relatively low in December 2021.

Turning now to the outlook for inflation in coming months, there is need to highlight two scenarios. The first scenario is one in which the government implements sooner or later the key reforms agreed with the IMF. These include full Rs 50 levy per liter on petroleum products, reintroduction of sales tax on petroleum products, increase in the electricity tariff by close to 40%, near dou bling of the gas tariff, and transition from the managed float of the rupee to a market-based exchange rate policy.

Simulation of the Macroeconomic Model reveals that these measures can lead to more than 10 percentage points increase in the rate of inflation following their implementation. As such, the rate of inflation could exceed 35% in this scenario.

The second scenario is when the lack of implementation of the agreed reforms leads to suspension or termination of the IMF (International Monetary Fund) programme. The result will be a virtual drying up of capital and loan inflows into Pakistan and lead to the absence of foreign exchange reserves to honor the external debt repayment obligations. In this case there will large shortages generally and a breakdown of normal economic operations in the country. The rate of inflation could be even higher and rise to above 50%. For example, Sri Lanka currently has a rate of inflation close to 60%.

Both scenarios will require very skillful management of the economic and social fall out of very high inflation. The risk of a large-scale public protest has to be anticipated and managed through progressive taxation and targeted reliefs and subsidies. Overall, the economy of Pakistan is likely to remain in the environment of severe stagflation in 2023.

Copyright Business Recorder, 2023