The rate of inflation, as measured by the Consumer Price Index (CPI), has been persistently rising since September 2022, on a year-to-year basis. It was 23.2 percent in September 2022 and by April 2023 it has risen to 36.4 percent, a big jump of 13.2 percent points in seven months. This rate of acceleration in the rate of inflation has seldom been observed before.

There is a need to find the reasons for the surge in the rate of inflation. Answers to this question will help in predicting what the rate of inflation will be in coming months. There is a general assessment that the year, 2023-24, will witness a major decline in the rate of inflation.

For example, the IMF has projected that from the first 10-month average of over 28 percent in 2022-23, the rate of inflation will fall to a 12-month average of 21.9 percent in 2023-24, with the end of period rate of inflation in June 2024 of only 16.4 percent.

The first explanation for the rising rate of inflation is that the floods led to major domestic supply shortages in basic food items. This is vividly highlighted by the jump in the price of rice. The crop was badly hit by over 20 percent by the floods. Consequently, while the price increase was recorded at 39.8 percnet in September 2022, it had risen to 87.8 percent by April 2023. A similar pattern is observed in many other domestically produced food items.

The other factor contributing to the acceleration in the rate of inflation is the faster rate of depreciation in the value of the rupee, leading thereby to higher rate of inflation in imported consumer goods. According to the merchandize trade statistics of the PBS (Pakistan Bureau of Statistics), the decline in the value of the rupee on an annualized basis was 37.1 percent in September 2022. This has risen to 54.8 percent by April 2023.

A third factor is the sharp decline in the value and volume of imports which has contributed to a more rapid increase in the domestic prices of imported goods. The policy followed by the SBP of physically controlling the volume of imported goods is primarily responsible for the upsurge in domestic prices in relation to import prices.

This is highlighted by the fact the dollar value of imports showed a decline of 18.5 percent in September 2022, but by April 23 the fall in imports has increased to 55.7 percent. This suffocation of imports, caused by the need to restrict the size of the current account deficit in the face of falling foreign exchange reserves, has led to shortages of imported goods and resulted in a bigger increase in the domestic prices of imported goods as compared to the rise in the imported price. The examples given below clearly highlight this higher increase in domestic prices, as of March 2023.

============================================================================================                              % Increase in Import Price (in Rs) and                          the % Increase in Domestic Price - March 2023============================================================================================Imported Item            Change in       Increase in              Increase in     Difference                         Volume of         Import               Domestic Price       (%)                              Import         Price in Rs                  (%)                            (%)             (%)============================================================================================Tea                       -12.4             33.0                     105.2              72.2Spices                      0.8            -10.0                      22.1              32.1Palm Oil                    5.4             39.4                      41.5               2.1Medicinal Products        -36.4            -28.9                      20.4              49.3============================================================================================Source: PBS============================================================================================

A clear example is that of tea. The volume of imports has been brought down by 12.4 percent by import restrictions. Consequently, while the landed price has increased by 33 percent, the resulting shortage has led to phenomenal over-doubling of the domestic price. Similarly, with an over 36 percent decline in the volume of imports of medicinal products, the rate of increase in domestic prices is more than double the rise in import prices in rupees.

As opposed to this, the volume of palm oil imports has increased significantly by over 5 percent. Consequently, the increase in the domestic price of vegetable ghee is, more or less, the same as the rise in the import price (in rupee) of palm oil.

Fortunately, there has been a positive factor which has reduced somewhat the rate of inflation. International commodity prices had risen sharply in March 2022 in the aftermath of the global recovery from Covid-19 and with the onset of the Russia-Ukraine war. They have since been falling. By March 2023, the import prices in dollars has fallen of palm oil, pulses, wheat, and POL products by 15 percent, 16 percent,7 percent and 6 percent, respectively.

The fundamental question is that if after September 2022 a policy of market-determined exchange rate had been followed instead of keeping the value of rupee artificially high and strongly curbing imports physically would the rate of inflation been lower? Following the withdrawal temporarily of this policy with pressure from the IMF, we appear to be back again to curbing imports physically and the value of imports has fallen by 56 percent in April 23 as compared to a decline of 12 percent in the first quarter of 2022-23.

Given the above analysis of the factors contributing to rising inflation since September 2022, the question is what is the outlook for the rate of inflation in coming months? This will depend, first, on the extent recovery of outputs during the forthcoming Kharif season of major crops like cotton and rice. The output of vegetables and fruits should also pick up. This will lead to some moderation in the rate of inflation in food prices.

However, the big question mark is regarding the future trend in the level of foreign exchange reserves and whether the IMF programme is revived or not. Already, the reserves have fallen by 55 percent since the beginning of 2022-23 and lumpy repayments are due in coming weeks. There continues to be the risk of an impending default. If this happens, then the rate of inflation could spike up to above 60 percent.

Therefore, the optimism of the IMF that the rate of inflation of 36.4 percent currently will fall sharply to 16 percent by June 24 may only be possible if the IMF programme is back on track. Further, Pakistan will be required to able to enter into a new three-year programme with the IMF after June, which leads to a substantial increase in the inflow of external financing.

Copyright Business Recorder, 2023