The CPI numbers for March 2018 reiterate the view that inflation is not an issue in Islamabad’s ongoing quest for macroeconomic stability. The headline inflation stood at 3.25 percent last month, which is not a surprise as the market was also expecting subdued inflation. The excess supply amid higher than global prices in staple food items is keeping the inflation dragon at rest despite rounds of currency depreciation in the last few months.

It’s an ill perceived notion that inflation and currency depreciation are strongly correlated. Yes, the sharp currency depreciation in 2008 had inflationary consequences owing to lower-than-international food prices at home back then. Plus, the demand pressure was there before the currency depreciation, as supply of energy and other industries were not there to meet the growing demand. The SBP had started its tightening cycle much before the crisis had hit the market.

Now, the economy has grown in roughly the last two years due to capacity expansion in power and other industries. And one of the reasons of higher current account deficit today is higher machinery imports. The monetary demand is not showing any signs of overheating. Hence, no inflationary pressures in short to medium term.

There were confusing remarks in January 2018 monetary policy statement that implied that positive output gap is creating inflationary pressures. The positive output gap means that demand is higher than the full economic capacity. However, in March 2018, the SBP said that the demand pressures are managed by better utilization of existing capacity and continued addition in installed capacity.

These are confusing statements spread over two months where in January 2018 the SBP said that demand is outstripping capacity, whereas in March 2018 it says that demand is being met by capacity. The latter seems more accurate.

The SBP expects FY18 inflation to land between 4.5 and 5.5 percent whereas inflationary expectations are not high either as per IBA-SBP consumer confidence survey. FY19 inflation is expected to remain within 6 percent.

The average inflation for Jul-Mar 18 stood at 3.8 percent and full year average inflation is likely to hover around 3.5-4 percent, which is much lower than SBP expectation of 4.5-5.5 percent. There are some pressures on core inflation that stood at 5.8 percent in March 2018 as compared to 5.2 percent in the previous month.

However, trimmed core inflation that came down from 4.3 percent (Feb-18) to 4.1 percent (Mar-18) as a one-off steep hike in education (MoM 4.9%; YoY 17.6%) explained high core inflation in Mar. The heavy weight (house rent) in core inflation is on a downward trajectory which is visible from moving averages.

Thus, inflation is not an issue, and demand is well managed owing to enhancing capacities. However, this does not mean that tightening is not necessary for attaining external account stability. Yes, in short term (may be next 4-8 weeks) exports may remain high due to one-offs (wheat export) and imports may not peak as peak summer is still month or two away. But that surely does not mean stability in medium term. Hence, inflation or no inflation, monetary tightening is warranted in next two reviews.