Spurt in inflation

Inflation has hit a double-digit rate of 10.3 percent in July 2019. This has happened after a gap of over six years. The spurt in inflation has been happening since September 2018 when it started at 5.2 percent. It rose to 6.2 percent in December 2018, to 9.4 percent in March 2019 and now to 10.3 percent.
What factors have contributed to the galloping inflation? Is the spurt likely to continue? How high will the rate of inflation go and what are likely to be the factors that will determine the pace and the maximum rate?
Answering these questions requires the determination of which products and services have shown the biggest increase in prices on a year-to-year basis. The first group consists of energy costs. The gas tariff on average has gone up by 143 percent, electricity tariff has increased by over 11 percent and motor fuel by 23 percent. Combined together these three items account for more than one third of inflation of 10.3 percent in July.
The second group consists of food items like vegetables, wheat and meat, all with price increases above 10 percent. The third group is of food items on which additional taxation of sales tax or excise duty has been imposed in the 2019 -20 Federal Budget. The best example of this is cigarettes, with a price increase of 38 percent in July. Prior to the budget the rise in price was much less at 15 percent. Other items which have experienced price increases due to the budget are sugar, cotton cloth and vegetable ghee. Overall, the budget has contributed to a rise in the inflation rate of over 1.5 percentage points. The budgetary impact has been regressive in character.
This is further substantiated by the narrowing down of the inflation differential among different quintiles of the population. Six months ago, the inflation rate for the lowest quintile was only 3 percent while that for the top quintile was over 8 percent. This has narrowed considerably by July. Now the inflation rate for the lowest quintile is 9 percent and 11 percent for the highest quintile. The gap has been reduced from 5 to 2 percentage points only. Clearly, this is a reflection of the faster rate of inflation in food prices in recent months. It also explains the increasingly widespread protests against the rise in the cost of living.
There is no doubt that the spiraling of the inflation rate since June 2018 has been caused more by cost-push factors including the big depreciation in the value of the rupee of 32 percent in the last one year. Other factors that have contributed have been the record level of borrowing from the SBP which has involved massive printing of money. On top of all this, have been the more than once big increases in gas and electricity tariffs.
What then is the outlook for inflation? The IMF Staff Statement on the new Program projects the average monthly rate of inflation at 13 percent in 2019-20. The expectation is that by the end of the year it will fall somewhat to 11.8 percent. For this to happen the inflation rate can be expected to continue rising from the 10.3 percent in July and then start falling in the latter part of the year.
A likely path of the rate of inflation is that it will approach a peak of 16 percent to 17 percent by December 2019 and then slide down to below 12 percent by June 2020. The speed with which it approaches the peak rate will largely depend upon the rate of depreciation of the rupee. IMF expects the rupee devaluation to be over 27 percent so as to ensure that the current account deficit is more than halved in 2019-20 from the level in 2018-19 of $13.6 billion. If the deficit does not drop appreciably in the first quarter of the current financial year then an acceleration in the rate of depreciation in the value of the rupee can be anticipated with consequential impact on inflation.
There are two other major risk factors with regard to the rate of inflation in 2019-20. The first relates to the budgetary target for increase in tax revenues of FBR by almost 45 percent, a near impossible target. In the event of a shortfall in the first quarter, additional taxation could be asked for by the IMF in the Program review. This may lead, for example, to resort to enhancement in tax rates in sales tax and/or excise duty and thereby lead to a further rise in prices.
The second risk factor relates to the international price of oil, which has been fluctuating currently on a, more or less, day-to-day basis. This uncertainty is largely due to the impact of the trade war between the USA and China and the movement of oil tankers in the Strait of Hormuz and the Persian Gulf. The forecast for 2019-20 of the price of Brent crude per barrel is $67, about $4 above the current price. The IMF inflation projection is based on little change in the price. However, if the oil price does increase then it will add further to inflationary pressures in Pakistan.
The country today is confronted with the worst form of 'stagflation'. The GDP growth rate is likely to be below 3 percent in 2019-20 with inflation approaching a high double-digit rate. Unemployment is also rising and the unfortunate reality is that over one million workers will not be able to find jobs in 2019-20. This stands in sharp contrast to other South Asian countries like India and Bangladesh where the inflation rate is low single-digit while the GDP growth rate is close to 6 percent.
The year, 2019-20, promises to be a very difficult year both economically and politically. The ability of the people to face higher unemployment and inflation simultaneously has, more or less, reached its limits. Any widespread public demonstrations will mean disruptions in economic activity and a further loss in the growth momentum. This must, of course, be avoided at all costs.
(The writer is Professor Emeritus at BNU and former Federal Minister)