Galloping inflation

Pakistan is seeing today an unprecedented hike in the rate of inflation. The CPI has risen on a year-to-year basis in the month of February 2023 by as much as 31.5%. It has spiraled up from 24.5% in December 2022 and 27.6% in January 2023.

The month-to-month rate of inflation has also shown a sharply rising tendency. It was recorded at 4.3% last month as compared to 2.9% in January and only 0.5% in December.

There is also a big divergence in the rates of inflation among groups of commodities and services. The highest rates of inflation are observed in food and beverages, especially in perishable items, of 47.6% and 53.1%, respectively. Clearly, the impact of this high inflation has been significantly more on the lower income groups, thereby leading to a likely big drop in nutrition levels, especially of children.

Pakistan also has today one of the highest rates of inflation. For example, the rate of inflation is only 6.5% in India and 8.5% in Bangladesh. Pakistan is in the group of countries with a high level of external financial vulnerability due to the low level of foreign exchange reserves and the risk of default or the situation following default leading to a big depreciation in the value of the currency. Some of these countries are shown in Table 1.

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                       Table 1
Extent of Currency Depreciation and Rate of Inflation
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Countries             % Depreciation       % Rate of 
                      of currency           Inflation
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Argentina`            83.7                       98.8
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Ghana                 84.9                       53.6
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Sri Lanka             71.1                       50.6
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Turkiye               33.3                       55.2
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Pakistan              54.9                       31.5
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Fortunately, Pakistan still has a lower rate of inflation than the above-mentioned countries. However, in the event a stage is reached when external debt repayments cannot be honored then the rate of inflation could rise much further and exceed 50%.

There are other factors superimposed on the high depreciation of the rupee which on a month-to-month basis have led to an increase in the rate of inflation. This includes the transition to a market-based exchange rate policy in January, the mini-budget with Rs 170 billion of additional taxation and a big jump in gas tariffs.

An analysis of the month-to-month rate of inflation in February indicates that prices of a number of items have been affected substantially by the policy moves. This includes cigarettes, gas and motor fuel, which have shown a rise in February in relation to the level in January of 15.6%, 62.6%, and 16.5% respectively.

The other major factor contributing to higher inflation is the supply shortages, especially in food items, due to the ravages of output caused by the floods. Consequently, we are observing extremely high increases in prices of rice, chicken, onion and tomato of 77.8%, 96.9%, 418.7% and 62.7%, respectively. However, it is not clear why the price of wheat flour is up by as much as 55.9%. This may be attributed to speculative behaviour in anticipation of an impending shortage.

What is the outlook for the rate of inflation in coming months? There has been a reversion back to a market-determined exchange rate policy in the last few days and the rupee has fallen by 7%. This process is likely to continue till the finalization of the ninth IMF programme review. Thereafter, the rupee may stabilize and appreciate somewhat.

There are other factors, which could impact on the rate of inflation. The Monetary Policy Committee of the SBP announced recently an extremely big increase in the policy rate of 300 basis points. This has apparently been done to counter inflationary moves like fiscal adjustments and exchange rate depreciation. However, the impact of higher interest rates on the rate of inflation in Pakistan remains ambiguous.

The MPC now expects the average rate of inflation in 2022-23 to be in the range of 27% to 29%. In effect, this amounts to a projection that the average rate of inflation from March to June 2023 will be in the range of 29% to 35%.

Clearly, the expectation is that the rupee will continue to slide downwards. On top of this, there will be a big surge in electricity charges, including the imposition of a lumpy surcharge. There is a big shortfall in the revenues from the petroleum levy and prices of petroleum products will continue to show an upward trend due also to a likely higher international price of oil and lower value of the rupee.

The outlook for the rate of inflation during the next few months is closer to the upper end of the forecast by the MPC of 35%. The persistence of such a high rate of inflation and even higher increases in food prices raises the likelihood of social unrest. It is already visible in the protests by people who are having difficulty in buying wheat flour.

The government needs to be prepared to counter the misgivings of people at this time. Perhaps the annual budget for 2023-24 will need to be presented earlier and include major proposals for progressive taxation and big cut in expenditure which can be used largely to provide relief to the poor in the form of larger cash transfers and targeted subsidies.

Copyright Business Recorder, 2023