The IMF expects FY20 average inflation at 13 percent and period end at 11.8 percent, while the market is expecting lower. The latest MPS decision to take policy rate at 13.25 percent is probably based on the IMF projections. The catch is in the methodology which according to sources is about to be implemented by this fiscal year i.e. the July number to be published in the start of August would be of new methodology.
The PBS is going through the exercise of rebasing for the past 2-3 years and it is believed to be changed from FY16 while the current methodology is using FY08 base. The new methodology appears more realistic as it is incorporating the components of modern economy, and there will be a case of separate measures for urban and rural CPIs, which is good for taking informed business decisions. Plus, the flaws in energy – electricity and gas, prices within the existing methodology may well be taken care of in the new CPI, to some extent.
The flipside is that the CPI of a few components in the new methodology will result in higher inflation and that could affect the monetary policy decisions. Although, in the latest MPS, it was hinted that the tightening cycle is complete and now onwards the decision will be based on data and economic factors. In fresh methodology, the data points would be changed and that could compel any further increase in interest rates. However, it is still pre-mature to say anything before the numbers are released and presented for analysts’ community to redo their forecasts.
One important component to be in the rebased CPI is restaurants and hotels. The eating out trend has visibly increased in the last decade or so with reasonable budget of urban households spent on recreational activity of Pakistan’s modern economy. The weight of the sub index is said to be increased from 1.2 percent in FY08 base to 6.2 percent.
The inflation of restaurants and hotels in FY19 based on new base hovered around 8-11 percent versus 5-7 percent on old base, and with 5 times higher weight, the impact on headline inflation could be significant. This would imply higher CPI in FY19 versus FY18, just based on this fact and this partially explains aggressive tightening. The question is what would be the trend of sub index in FY20 – the number started tapering off in the last quarter and higher base could result in lower eating out inflation going forward.
Whatever be the case, it is going to be an important variable, especially in urban centers – the weight of restaurant and hotel is 65.1 percent for urban. The weights seem reasonable; and it should be incorporated in new GDP (rebasing is due as well) where the GDP to lift up due to this growing service.
Other similar services and goods – like beauty products and health care will have higher weights as well. These are classified in miscellaneous goods and services – sub index weight is to increase from 2.8 percent to 5.6 percent. Another interesting observation is in education where the weight in the overall CPI is almost unchanged, but 77.5 percent of education weight is urban. This is probably reflecting mushrooming private education growth in urban centers while the rural areas are cutting sorry figures. The growth in education CPI remained higher in new base between May17- Jan19 – reflecting higher CPI for FY17-FY19, especially in urban centers.
The most significant changes are to be observed in energy prices. In case of electricity, the old methodology only uses base tariff, completely disregarding the fuel adjustments. In the past few years, the base tariff did not change at all while the fuel adjustments take place every month based on international fuel prices and currency fluctuations. It is the right approach to have fuel charges as part of CPI as consumer pays the full bill including taxes and other adjustments. Thus, any increase in oil prices or currency depreciation would have a direct (and lagged) impact on CPI.
In case of gas prices, the wrong methodology of using simple weights is to be rightly replaced by weighted average. This space has raised the issue when gas prices increase took place a few months back and even after revising the gas price increase was 85 percent. This positive change may partially nullify the impact of fuel prices adjustment in electricity within the housing, water, electricity, gas and other fuels.
In a nutshell, the new methodology is going to be better than the previous one as it would be a better reflection of household consumer basket. It is a more streamlined approach to compute CPI as it is based on latest census and having separate rural and urban population.
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