Rising inflation

The rate of inflation in Pakistan, as measured by the year-to-year change in the Consumer Price Index (CPI), has been rising steadily over the last one year. It stood at 3.2 percent in March 2018. A year later it has, more or less, trebled to 9.4 percent. This is already the highest rate of inflation in the last seven years.
There is a need to understand the factors that have contributed to the spiraling of the rate of inflation. Which goods and services have experienced the biggest increases in prices? What has been the impact on the cost of living of households at different levels of income? Is there a difference in the rate of inflation at different locations in the country? The objective of this article is to attempt an answer to these questions.
The decomposition of the rate of inflation in March 2019 provides some interesting insights. The contribution to the rise in the CPI can be distributed between food, energy and other non-food goods and services. Estimates are that 32 percent of the inflation is due to the rise in food prices. Energy items have contributed 22 percent and the remainder, 46 percent, by non-food and non-energy goods and services.
There are two items, in particular, which have made an extraordinary contribution to inflation in the country. The first is the big jump in gas prices announced by the new Government. PBS estimates that on a year-to-year basis the gas price has gone up by 82 percent as of March 2019. The second item is tomatoes, with a more than tripling of the price. Together, these two items alone account for almost 28 percent of the inflation in the country.
There is need also to disaggregate the increase in the rate of inflation in the CPI from July 2018, when it stood at 5.8 percent, to 9.4 percent by March 2019. The increase in food prices has been greater, from 3.5 to 8.4 percent as compared to the increase in non-food prices, from 7.4 percent to 10.1 percent. Consequently, over the last nine months, the rise in the rate of inflation has been caused, more or less, equally by food and non-food prices.
However, the rate of inflation in food prices is still somewhat lower at 8.4 percent then the rise in the overall CPI of 9.4 percent. Given that the share of expenditure on food is higher in the case of the lower income groups it is likely that their cost of living has gone up less than in the case of households with relatively higher levels of income.
The SBP produces a monthly publication called the Inflation Monitor. This is a very useful publication and gives the rate of inflation by income group and in different cities of the country. The latest publication is of February 2019. The reported estimate is that the inflation rate on a year-to-year basis is higher as the income group increases. It is 6 percent in the case of the lowest income group and almost 10 percent for the highest income group, earning more than Rs 35,000 per month.
Further, this publication also highlights the big divergence in the rates of inflation in different cities of the country. Contrary perhaps to perceptions, the inflation rate as of February 2019 is actually lower in the large Metropolitan cities. It is 7.4 percent in Karachi and only 5 percent in Lahore, as compared to the nationwide average of 8.2 percent. In some of the smaller cities like Quetta and Peshawar it is as high as 11.2 percent and 10.2 percent respectively.
The PBS currently gives equal weight to all seventeen cities from which price data is collected on a monthly basis for construction of the CPI. If, however, higher weights are given to the larger cities in line with the population then it appears that the rate of inflation is significantly lower than that estimated currently by the PBS.
What is the outlook for inflation in coming months? The second quarterly report of the SBP has projected that the monthly average of the rise in CPI will range from 7.5 percent to 8.5 percent in 2018-19. There is a stronger likelihood that it will be closer to the upper end of the range. This implies that it could approach 11 to 12 percent by June 2019. This will be fuelled further by the recent increases in POL and medicine prices.
Clearly, one of the major factors that have contributed to the upsurge in the rate of inflation in 2018-19 is the on-going depreciation in the value of the rupee. Between March 2018 and March 2019, the value of the national currency has gone down by 21 percent. Historically, on the average, a 1 percent fall in the value of the rupee has meant a 0.35 percent rise in the overall CPI due to the increase in the landed cost of imported items. As such, due to this effect alone, the inflation rate in March 2019 should be higher than March 2018 by 7 percentage points. The difference, however, is actually just over 6 percentage points. This highlights the fact that the full impact of the Rupee devaluation has not yet been fully transmitted into higher domestic prices.
Also, the increase in energy prices is having a cost push impact on the prices of a large number of items. Further, the high rate of expansion in money supply, especially in currency in circulation of 16 percent, is leading also to demand-pull inflation. This has been caused by the printing of money to finance the record level of borrowing by the MOF from the SBP.
The Federal Ministry of Finance has recently raised an objection with the PBS for inflating the increase in the CPI in March 2019 by almost 1.2 percentage points. Apparently, this has been caused by faulty averaging of the increase in gas and electricity prices. Accordingly, it is argued that the SBP has wrongly raised the policy rate to 10.75 percent recently.
However, the policy rate is not linked to the overall CPI but to the 'core' rate of inflation. This measure is derived by excluding both food and energy prices. As such, gas and electricity prices are not part of the 'core' price index. In fact, the 'core' rate of inflation stands currently at 8.5 percent. Normally, the policy rate of the SBP is at least two percentage points above the 'core' rate of inflation. As such, the policy rate at 10.75 percent does not appear to be significantly biased upwards.
There is unfortunately the prospect that the process of depreciation of the Rupee will continue, thereby sustaining a double-digit inflation for some time. As such, in the presence of growing prices and rising unemployment, there is the likelihood that almost 4 million people could fall below the poverty line in 2018-19.
Therefore, the Government must give high priority to social protection at this time of adversity. First, there is need to raise the cash transfers to poor families by 10 percent or so under the BISP. Second, the number of outlets of the Utility Stores Corporation must be increased substantially.
It is indeed unfortunate that the new Government is unable to give substantial relief to the people at this time as per its election promises. The least that can and should be done is to implement expeditiously the various anti-poverty initiatives announced recently by the Government under the new Ehsaas programme.
(The writer is Professor Emeritus at BNU and former Federal Minister)