Inflation continues to be tame despite currency depreciation, increase in fuel prices and a growing twin deficit. Inflation was supposed to remain partially insulated to currency depreciation as the domestic food and other commodity prices were already at a premium to international prices (For details read “impact of currency depreciation’’ published on Dec 14, 2017).
The CPI at 3.8 percent in February is lower than low inflationary expectations of analysts. On monthly basis, the headline number fell by 0.3 percent which is after no change in Jan and a decline of 0.1 percent in Dec. That is three months in a row of depressed inflation. The question is why inflation is low and how has it remained unaffected to currency movement, dearer oil and growing external vulnerabilities.
Well, three fifth of CPI basket is food and house rent and both are not adversely impacted by any of the above mentioned factors; hence the CPI is low. Why are food prices low? There are number of factors - one prime reason is that in past few years, especially after 2008, food prices at home increased too much relative to international prices and because of better pricing in sugar and wheat, there is supply glut in major food commodities at home.
The ongoing round of food commodity price reversal in the world has no adverse impact on prices in Pakistan. The drop in prices of perishable food items in the past three months is too much which is continuing in March; but sooner or later the cycle would reverse.
The house rent index is not likely to be affected by any international changes as the real estate prices in domestic economy are no longer moving up because of efforts on documentation in the sector and that may keep the house rent index in check. The index has been moving in range of 5-6 percent for past few years and it may continue to remain in the band in near future.
The catch is in the transport index (7.2% weight), electricity (4.4% weight) and gas (1.6% weight). All have direct impact of higher international oil prices. In case of transportation, the monthly increase registered at 1.0 percent, while on yearly basis the prices are up by 5.6 percent. The sub index might not be increasing in tune with increasing global prices.
For instant, motor fuel sub index increased by 3.3 percent and 2.1 percent respectively in Jan and Feb while petrol prices increased by 5.2 percent and 3.7 percent respectively in same period and the increase in diesel is even higher. The low motor fuel increase is probably due to CNG prices which have remained virtually unchanged. The weight of CNG could be higher in CPI (which was last rebased in 2008) than what is the ground reality today.
In case of electricity and gas, tariffs are bound to increase as tariff differential subsidies or claims are growing while the prices are sticky. A conservative estimate is of 15 percent hike in each due either in interim period or in initial days of new government. That would increase the CPI by 1 percent.
Even after all that, the CPI may remain low in near to medium term. In the coming months (Mar and Apr), high base effect last year would keep at around 3.5 percent (March) and 2.5 percent (Apr), this will be followed by 4-5 percent inflation in May and June. The full year average is likely to hover around 3.5-4 percent.
The good news is that because of low inflation, the induced IMF pressure on currency depreciation may be low. After the rupee 4-5 percent depreciation against USD in December amid USD weakening against other currencies, the REER computed by IMF and published by SPB has moved from 124.1 (Nov) to 119.1 (Dec) and is likely to come down to 116 (Jan). The trend of adjusting REER to its equilibrium may continue and the IMF may not push for depreciation beyond a band of Rs120-125, as opposed to some circles fearing Rs135. Anyways, to curb imported demand, the monetary tightening may continue despite low inflation.
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