Dip in the rate of inflation

There is finally some good news on the rate of inflation. The month of June has witnessed a big dip in the rate of inflation in the CPI of 8.6 percentage points to 29.4% from 38% in May. This is the first decline since January 2023, when it was 27.6%. Thereafter, it has been rising steadily to reach the peak of 38% in May 2023.

The fundamental question is what explains the significant decline in the rate of inflation in June? Is this the precursor of a trend of falling inflation in 2023-24?

Numerous explanations have been offered for the 8.6% point drop in the rate of inflation in June. A recent editorial in Business Recorder has suggested that efforts may be under way to understate the rate of inflation to show some success in stabilizing the economy prior to the elections.

Another view that has been presented is that this is a reflection of the moderation in the rate of depreciation of the rupee of only 0.9% between March 2023 and June 2023.

A careful and close look reveals a likely alternate explanation. This can be referred to as the ‘high base effect’. The month of June 2022 saw an exceptional jump in the Consumer Price Index. On a month-to-month basis it rose by as much as 6.3% in June 2022. Prior to this the average month-to-month increase in the previous six months was only 0.7%.

Consequently, due to the big jump in the CPI in June 2022 there was a reduction in the rate of inflation in June 2023. Had the increase in June 2022 remained at 0.7%, the rate of inflation in June 2023 would have been significantly higher at 35.9%. The ‘high base effect’ has been accentuated by the fact that in comparison to May 2023, the price index is lower by 0.3% points in June 2023.

There is a need, therefore, to explain the upsurge in the year-to-year rate of inflation in June 2022 by 6.3% points compared to May 2022.

This first major impact on the price level in June 2022 was the result of supply shortages in the immediate aftermath of the floods. Consequently, the month-to-month rate of inflation in food prices jumped to 5.5%. For example, the price of wheat, milk, potato and tomato soared in one month in June 2022 by as much as 13%, 8%, 35% and 9%, respectively.

The second reason for the jump in the price level in June 2022 was the withdrawal of the subsidy on electricity announced by the PTI government just prior to its departure. This resulted in a 52% jump in the electricity tariff in comparison to the level in May 2022. On top of this there was a big jump in the price of motor fuel of 37% during the month. Finally, the budget of 2022-23, announced in June, led to an upsurge in cigarette prices by over 8%.

Beyond the large impact of the ‘high base effect’ there is also evidence of reduction in the overall CPI in June 2023 relative to May 2023 of 0.3%. This is due to a significant drop during the month in the prices of wheat flour, pulses and livestock products.

The next question is what will be the likely trend in the rate of inflation in 2023-24? The latest IMF projection is 25.9%.The next few months will witness a continuation of the ‘high base effect’.

Other factors which will impact on the rate of inflation include implementation of the various reforms under the new Stand-by Arrangement with the IMF. This includes a full-fledged transition to a market-based exchange rate policy, continuation of very high interest rates and a big upward adjustment in the level of electricity tariffs.

If the rupee depreciation required to limit the size of the current deficit is big, then the extent of imported inflation will be larger. Further, there will continue to be persistence of high inflationary expectations.

Overall, the year, 2023-24 is likely to witness a moderate decline from the 29.4% rate of inflation in 2022-23. In the absence of any major negative development like difficulties in honoring external debt repayments, the inflation rate is projected to be in the range of 25% to 27% in 2023-24.

Copyright Business Recorder, 2023