The recent increase in oil prices to accelerate the pace of inflation will touch the rate to around 9 percent during the current fiscal year on the back of rise in commodity prices and input costs, analysts said. Ali Farid, an economist at Al-Falah Securities said that the OCAC raised domestic oil prices yet again for a third consecutive time in their last meeting. The average price increase is around 5 percent.
Oil companies have also raised the price of furnace oil by around 10 percent. With inflation soaring at around 8.8 percent, it is likely that another increase in the prices would send the price index into the double digits.
The State Bank of Pakistan's reaction to the rise in inflation could be seen in the last T-bill auction, where the yields on the 6 month paper was increased by a massive 53 basis points to 4.8 percent. However, it seems unlikely that the tightening in monetary policy would be able to curtail inflation.
Farid said that fuel contributes to around 7 percent in the CPI basket and has a 19 percent weight in the WPI. Hence, there would be a direct impact of the current price increase on inflation.
Till December, although oil prices had been rising in the international market, domestic oil prices were kept fixed by the government, consequently the fuel component of the CPI only rose by around 4.5 percent in the first six months.
However, with the increase in oil prices during January and now in February, the CPI index would get further acceleration. The indirect impact of the oil prices increase would be much greater in magnitude.
Transportation costs has another 7 percent weight in the index, it is very likely that the transporters would try to pass on the oil price increase to the consumers and a strike by transporters is expected.
Food prices also tend to move in tandem with transportation costs, since food has to be transported from the farms to the markets. Hence any increase in the transportation costs would filter down to an increase in the food prices, which has a major 40 percent contribution to the CPI index.
Given the current scenario and expected wheat shortage this year, it is likely that inflation would reach around 9 percent in the current year. Any further increase in the domestic oil prices would send the index into the feared double digits. Inflation models of (International Monitory Fund (IMF) also project the CPI index to cross double digits.
The SBP's dilemma regarding the trade off between curbing inflation and promoting growth still seems to be putting the bank in a confusing position.
In the new monetary policy, the Bank announced a full year target of money supply at around Rs 360 billion, whereas just in the first half money supply has increased by almost Rs 280 billion. Hence, controlling the money supply to the projected levels along with curbing inflation to around 7 percent, would require aggressive tightening in the monetary policy.
In the last T-bill auction, the bank has raised the cut off yield on the 6-month T-bill by 52 basis points to 4.86 percent. Curbing the inflationary pressures would require a sustained aggressive posture on monetary policy, which would be politically difficult for the bank to maintain given the GDP growth target of 7 percent.
The catch 22 for the SBP certainly seems to be getting more complex. The exporters are protesting against the increase in refinance rate to 5.5 percent, the transporters are complaining against the increase in fuel costs, the consumers are complaining against the increase in food prices and the industrialists are complaining about the increase in input costs.
Prudence would dictate that the government should take a much more aggressive stance on curbing inflation, even if it has to sacrifice the GDP growth target. Whereas a high growing economy might be a good enough indicator to lure foreign investors it certainly does not impress the general public if inflation is rising at a pace higher than the income growth.