CPI culprit: budgetary borrowing

As the curtain was raised on the CPI numbers for June FY12, it became clear that inflation for the entire fiscal year had remained within SBPs target of 12 percent, coming to 11 percent on a year-on-year basis for the outgoing fiscal. While the year-on-year change in June alone was 11.3 percent, the month-on-month increase was the lowest for this fiscal year at 0.04 percent. The apparent ebbing of inflationary pressures as seen from the month-on-month analogy can be explained by two key indices - food and transport. The food category saw its index decrease after having risen for the past three months. Given the over seven percent month-on-month decrease in the prices of perishable food items, these are largely responsible for pulling down food inflation this month. Amongst perishable goods, eggs and fresh fruit were the biggest losers relative to May 2012 as far as prices are concerned. Fresh vegetables, as well as onions and tomatoes, which are listed separately from the fresh vegetables category, also registered a decrease relative to the previous month, as did fish and chicken. Though the slump in perishable commodities can largely be attributed to inefficiencies in the supply chain of organic food items, one must also heed the global slump in commodity prices, in general, which will likely affect domestic food prices after a lag if the impact has not been felt already. But decreasing global commodity prices did leave an impact on two other key categories - the effect of decreasing international oil prices on transport. The year-on-year inflation seen in the transport category in June was in single digits for the first time in FY12. The Oil and Gas Regulatory Authority (Ogra) announced a reduction in POL prices at the beginning of June, as well as in mid-June. This brought down motor fuel prices in Junes CPI by nearly seven percent relative to May 2012. However, the effect is yet to be seen in transport services, which increased by over three percent in June relative to May 2012. Housing, Water, Electricity, Gas and Fuels sub index showed a paltry month-on-month increase of 0.05 percent in June FY12, helped by no net change in house rent and prices of electricity and gas during the month. Amongst other categories with a smaller weight in the index, health is worth mentioning, as the month-on-month increase for this sub-index was the highest for this fiscal year. The increase comes at the heels of rising prices of drugs and medicines, medical equipment, medical tests and doctors fee. Going forward, the reduction in international oil prices will continue to pull down the transport sub-index, with Ogra having announced a further reduction in POL prices for July. The reduction in prices of other commodities globally will also likely reduce food prices domestically. However, SBPs last monetary policy statement was abuzz with concerns about fiscal reforms and excessive government borrowing, and the resulting persistence of inflationary pressures despite sluggish GDP growth. Fiscal borrowing from the banking system has an expansionary impact that is countering the effect of weakening domestic demand. The central bank said it "is not expecting a sharp increase in inflation but its continuation around current levels in FY13," stressing on the need for limiting government borrowings from the banking system. In fact, the rapid growth in the governments domestic debt is also numbing the efficacy of SBPs monetary policy. Overall, while there is a likelihood of seeing a decrease in inflationary pressures owing to a global reduction in commodity prices, an expansionary fiscal stance, especially considering this is an election year, will pull up inflationary expectations and pressures. It seems that the target of 9.5 percent for inflation for FY13 will be a tad idealistic, with SBP stressing, "Inflation expectations cannot be effectively anchored around single digit targets without limiting fiscal borrowings from the banking system, particularly the SBP."

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Major CPI groups - June 2012
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                              Y/Y chg  M/M chg
                                  (%)      (%)
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CPI general                     11.26     0.04
Food & non-alcoholic beverages   9.94    -0.66
Non-perishable                   9.66     0.58
Perishable                      11.73    -7.88
Housing, water, elec, gas       10.75     0.05
 & other fuels
Clothing & footwear             15.43     0.53
Health                          14.25     2.33
Transport                        8.85    -1.59
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Source: PBS