The monthly inflation report card has brought no reason for respite for the policy makers. The deceleration in headline CPI proved short lived, breaking its three-month long streak. Worryingly, monthly inflation is back in 30s, with September 2023 reading qualifying for the top 10 worst-ever (recorded) months. Will predictions of a slowdown in average inflation during FY24 prove to be a mirage?
The central bank certainly doesn’t seem to think so. In its latest monetary policy statement announced just a fortnight ago, the SBP correctly predicted that headline CPI would rise “significantly” in September before tapering off in subsequent months. Although a pause in CPI’s deceleration due to upward adjustment in energy tariffs was well-anticipated, the rise in core inflation (non-food, non-energy) raises concerns over the robustness of SBP’s forecast. In fact, on a national basis, core inflation indicators appear to have reached a fresh peak, breaching the levels recorded in May 2023. Will the second-round impact of the commodity and currency price spirals witnessed over the last 24 months, unravel all hopes of taming the inflation dragon in near term?
There may be some hope, and it stems from the least of all expected places. Food inflation – with its 34.6 percent weightage in national CPI - fell to its lowest level since November 2022. At 33.1 percent, the deceleration may not seem much, especially considering that month-on-month reading inched forward by 1.7 percent compared to just 0.57 percent during the previous month. But the headline numbers do not tell the full story.
During September 2023, the food basket’s contribution to headline CPI fell to 41 percent after peaking at 51 percent last month (and averaging at 50 percent for the preceding 12 months). This is a very significant positive development, especially considering that the deceleration has come from the non-perishable basket. Note that the contribution of the non-perishable basket to headline national CPI had climbed to a peak of 49 percent during August 2023, and averaged at 45 percent over the last 12 months. The same declined to 40 percent during September 2023. The non-perishable inflation index also rose at just 0.87 percent on month-on-month basis, its second-lowest MoM reading in 20 months.
In the coming months, the plateauing of non-perishables prices could prove to be the turning point for headline inflation – if it does not prove to be ephemeral. Various exogenous factors may provide the much-needed tailwind to this slowdown, from the clampdown on informal forex market which has stabilized the rupee, to the slowdown in global commodity prices, which helped pull down global food price index by an average of 25 percent from its peak levels 18 months ago. But most importantly, non-perishable food commodity prices in the domestic market may have finally reached a level where demand destruction could be taking place in a substantive sense.
Whatever the explanation, if no new exogenous disruption occurs, it is likely that the deceleration in food inflation indices would continue in the near term, specially considering that the perishable sub-index witnesses a seasonal slowdown from November to January historically. Importantly, the rise in food index during September 2023 was mainly driven by prices of sugar and onion, two heavy weights that will witness a slowdown by calendar year end as crushing and harvest seasons begin. The wildcards could be global rice prices and its impact on the local grain market, and availability of water in the upcoming rabi planting season.
In any case, if the tailwind from currency stabilization efforts and weak commodity prices in the global market persist, the deceleration from the food index may prove sufficient to finally bring down average headline inflation for FY24 close to official target. Could the second-round impact due to wage pressures prove sufficient to cancel out the downward pull from the food index seems unlikely in an economy where food index alone contributes more than one-third to national CPI.
But forecasts have been wrong before!
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