The currency depreciated by 5 percent petroleum prices were up by a similar percentage. The question is how would it impact headline inflation? The one line answer is that there is no inflationary threat as it happened in previous rounds of depreciation. For details read “impact of currency depreciation” published on December 14, 2017.
Any inflationary impact of depreciation would appear come January 2018. December headline number stood at 4.57 percent versus 3.97 percent in the previous month, despite the fact that on monthly basis the CPI is down by 0.1 percent. It is the low base effect that worsened the December numbers as in December 2016; inflation was down by 0.68 percent.
The six month average stood at 3.75 percent. It is at very comfortable levels and merely seeing from the inflation lens, monetary tightening from current 5.75 percent discount rate is not warranted. However, taking current account slippages in the equation, the picture changes a bit. And the new finance team seems to have an open approach towards exchange rate and interest rate policies.
Let us attempt to try to see how the CPI would behave in the second half of the fiscal year. The transport index would see an increase of 5 percent in Jan18 with its weight of 7 percent in CPI; the net impact would around 0.35 percent on monthly inflation in January. Then the house rent index would have its quarterly recording due in January; with its weight of 20 percent, an anticipated one percent increase would add 0.2 percent in CPI.
Currency depreciation, and petroleum prices upward revision would have a marginal impact on food and other components of CPI; though the SPI numbers are negating any impact - at worse the index may increase by 1 percent on monthly basis in Jan18 and subsequently 0.5 percent increase each month till July will take the full year inflation at 4.5 percent which would be well within the yearly target of 5.5-6 percent.
The real interest rates would remain in positive territory. If the monetary policy committee has the hangover of Dar era, status quo would continue. But the fresh blood in the finance team may have different ideas. And BR Research is of the opinion that monetary tightening would have an impact on curbing import demand. Yes, the affect of exchange rate depreciation would be higher as this may not only help in curbing imports, but can also boost exports.
In case of hike in interest rates, auto financing can be slowed down to lower the import bill marginally Plus, it can slowdown the economic expansionary cycle. The MPS has to be more innovative as there should be steps to encourage exports growth by offering lower rates to exporting sectors; and to have better rates for expansion in import substitution industries. It is a tough call. At least, 25 bps increase in rates can be a sign of reversal in policy.
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