The statement released recently by the Monetary Policy Committee of the SBP (State Bank of Pakistan) indicates that the policy rate will remain unchanged at 22%.
This decision apparently takes into account the recent colossal hike in gas prices, which has added over 3 percentage points to the rate of inflation on a year-to-year basis in November. Consequently, there has been an upsurge in the rate of inflation from 26.8% to 29.2%.
However, the Monetary Policy Committee is optimistic that the headline rate of inflation will decline significantly in coming months of FY24. This is likely to be due to contained aggregate demand, easing of supply constraints especially of agricultural products, moderation in international prices of commodities and favorable base effect.
What are the projections of the average rate of inflation in Pakistan in 2023-24? The federal government has indicated in the Annual Plan for the year that the rate of inflation will be 21.9%. The IMF has revised its projection of the rate of inflation in Pakistan in 2023-24.
The July Staff Report following the approval of the IMF Stand-By Facility indicated that the average rate of inflation was likely to be 25.9%, with the projected rate in the last month, June 2024, at 16.2%.
The October 2024 World Economic Outlook report of the IMF contains a new set of projections for Pakistan. The projected average rate of inflation in 2023-24 has been revised downwards to 23.5%. However, the expected rate in June 2024has been raised to 17.5%.
The problem with the above two projections is that they imply a quantum decline in the average rate of inflation from November 2023 to June 2024. The average monthly rate of inflation in the first five months has been high at 28.6%.
This implies that the government projection of the annual average rate of 21.9% can be achieved if it falls sharply to 17.1% in the last seven months of 2023-24. Similarly, the latest IMF projection can only be achieved if it falls to an average of 19.8% from December 2023 to June 2024, with the rate at 17.5% in June 2024.
There is need to examine the trend in international prices of commodities. According to the World Bank commodity prices data base, the overall commodity price index has fallen to 110 in October-November 2023 from 130 in the quarter, October to December, of 2022. According to this data base, there has been significant decline over the year in many of the key imports of Pakistan.
The dollar prices of crude oil, palm oil, wheat, cotton and fertilizer are down by 4%, 12%, 30%, 8% and 20%, respectively. The depressed level of prices is likely to persist as the world economy is moving to a state of recession. Therefore, as highlighted by the SBP, the outlook for international commodity prices in the short term is favorable.
The second component of imported inflation is the rate of depreciation in the exchange rate. From January to June 2023 there had been very large decline on a year-to-year basis in the value of the rupee from 40% to 55%. However, since the rupee has stabilized, especially after August, the average depreciation on an annualized basis in the rupee has been limited to less than 28%.
The outlook for the exchange rate hinges on the level of foreign exchange reserves in coming months. The IMF had projected that with successful completion of the Stand-by Facility in 2023-24, the level of reserves would reach $9 billion by the end of the year. They currently stand at $7 billion.
The positive side of the outlook is that the current account deficit is well under control. It is unlikely to exceed $4 billion over the year as compared to the original projection of $6.5 billion.
However, the financial account of the balance of payments has become increasingly fragile. Non-debt creating inflows are showing only a modest rise. The vulnerability is due to the ebbing of external inflows, both from multilateral and bilateral sources, while inflows from private creditors have completely ceased. Consequently, amortization payments are now exceeding the new debt inflows. If this adverse trend persists then there will be growing pressure on the foreign exchange reserves which in turn will lead to faster depreciation of the rupee. Hopefully, larger inflows will resume after the IMF Executive Board approval of the second installment loan from the Stand-By Facility.
The other issue relates to the likelihood of further big increases in electricity and gas tariffs in coming months. There is also the problem of the quantum of the recent escalation in the gas tariffs. According to the PBS, this is reported at over 1100% in the Sensitive Price Index and much less at 520% in the Consumer Price Index.
The expectation is that there will continue to be quarterly escalation in power tariffs in order to limit the large circular debt in the sector. However, the regime of administered prices is likely to be facilitated by the significant decline in the international oil price. This has been transferred already in lower domestic prices of petroleum products, which will exercise thereby some moderating influence on the rate of inflation.
Based on the above assessments of the likely quantum of imported inflation in 2023-24 and movement in administered prices, projections have been made of the average rate of inflation over the year.
The BNU Macroeconomic Model has been used for projecting the rate of inflation in 2023-24, based on the following determining variables:
Rate of expansion in money supply (lagged by one year)
GDP growth rate
% increase in the Unit Value Index of Imports (in Rupees)
% Increase in Administered Prices
Inflationary Expectations (measured by the rate of inflation in the previous year).
For each of the above variables, likely high and low values have been taken. These values are used in the rate of inflation equation in the model.
The GDP growth rate in 2023-24 is expected to range from 2% to 3%. The rate of monetary expansion last year was 14.2%. The unit value index of imports in rupees is projected to increase by 5% to 10%.
The resulting projections are as follows for 2023-24:
=====================
(%)
Average June 2024
for Year
High 26.5 18.5
Low 24.2 16.7
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These projections are significantly higher than the annual projection by the federal government. They are also somewhat higher by 0.7% to 3% points in relation to the latest IMF projections.
Nevertheless, they do anticipate a modicum of relief in the coming months. The first five-month average in 2023-24 of the rates of increase in the CPI was 28.6%. It is projected to fall to between 25% and 21% in the next seven months of 2023-24. Hopefully, if the rupee remains relative stable and there is no big escalation especially in the power tariffs then the outcome could be closer to the IMF projection of 23.5% over the year, with the rate of inflation down in June 2024 to 16.7%.
Overall, the people of Pakistan have paid heavily for the historical peak in the rate of inflation in the last eighteen months. Topmost priority must be given to bringing the inflation rate down to single digit by January 2025, as expected by the SBP.
Copyright Business Recorder, 2023
The writer is Professor Emeritus at BNU and former Federal Minister
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