Over the past two years, rising inflation shattered records and surpassed analysts’ expectations. However, a reversal of this trend appears to be underway. Surprisingly, the Consumer Price Index (CPI) dropped to 11.8 percent in May 2024, down from 38 percent a year prior (as of May 2023). This marks a significant shift after a long and painful journey whose repercussions will linger for years to come. Nonetheless, the trajectory of high inflationary trends is evidently being curbed.
Historically, food inflation has been the primary driver of inflation in Pakistan, and this was notably the case in the preceding two years. Food inflation peaked at 49.8 percent last May but has now turned negative this May, indicating a decrease in the food prices index (by 0.17%) over the past twelve months, thanks to declining prices of wheat and other items.
Analysts had anticipated CPI inflation to decline to 13.7 percent, but the actual figure is nearly two percentage points below this, providing a positive surprise and much-needed relief for the nation’s populace. However, to dispel any confusion, the decrease in the inflation rate does not signify a reduction in overall prices but rather a deceleration in the rate of increase. For perspective, today’s food prices index, though lower, remains more than double what it was at the end of 2019, and the headline story echoes a similar sentiment.
Nonetheless, the recent decline is a welcome development. Food prices have decreased by 7.8 percent in the last month, primarily due to declines of over 20 percent in wheat and wheat flour, 35 percent in chicken, and over 50 percent in perishable items such as tomatoes and onions.
Energy inflation also eased in May 2024, declining by 2.7 percent due to decreases in electricity prices and LPG. However, the drop in electricity prices may be transient, potentially increasing post-budget. Similarly, falling petroleum prices may reverse direction following the imposition of GST or enhanced Petroleum Levy (PL) in the upcoming budget.
The upcoming budget is expected to exert overall pressure on inflation, as the government may end tax exemptions, increase taxes on petroleum, potentially raise the GST rate, and introduce new taxes, all of which could have inflationary impacts alongside increases in electricity and gas prices.
Nevertheless, even with these cost-push factors, overall inflation is projected to remain between 13-15 percent in the next year due to falling global commodity prices, sustained domestic demand destruction, and relatively modest currency depreciation. The State Bank of Pakistan (SBP) should maintain positive real interest rates to ensure the persistence of declining inflation and aid in achieving SBP’s medium-term target of 5-7 percent inflation by September 2025, with single-digit inflation becoming a tangible possibility.
A rate cut is highly likely, with real rates currently around 10 percent based on the current inflation rate. However, the SBP may proceed cautiously, considering outstanding payment obligations that could adversely impact the Pakistani Rupee (PKR), as well as assessing the inflationary impact of budgetary measures before implementing a rate cut.
That said, a 100 basis points (bps) cut on June 10th is almost certain, raising the question of whether it should be more substantial or not.
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