Like a fire, inflation, needs fuel to spread. And for Pakistan, there have been three fuel triggers throughout its recent history: private sector credit, high fiscal deficit and external price shocks. Luckily, none of these triggers is out of control to fuel inflation as yet.
However, with the dilution of high-base affect and poor food administration that created supply side bottlenecks in the last few months, headline inflation is back in double digits. CPI, which bottomed out last month, jumped by 10.5 percent year-on-year, while rising 1.4 percent on a month-on-month basis in November.
Although, the food and house rent inflation (63% of CPI basket) is likely to slide back to its mean owing to rather irrational hike earlier, conservatively speaking, the headline inflation in the next two months is seen around 11 and 12 percent, respectively.
Owing to Ramadan, two Eid festivals and sugar crises, the heavy weight food index pushed CPIs monthly average to 1.2 percent in the first five months of FY10 as compared to 0.8 percent in the second half of last fiscal year. But with easing food prices, this is likely to remain in control in the coming months while global crude oil prices are also expected to come down in December.
On the flipside, however, the upcoming 16 percent hike in electricity tariffs in January and 12 percent in April might put little upward pressure in the second half. These factors lead one to the assumption of an average 0.6-0.7 percent monthly increase in CPI for the remaining seven months of FY10. Hence, the expectation that yearly average of remaining seven months will be in the vicinity of 11.5 to 12 percent versus 10.3 percent in the Jul-Nov period.
Core inflation, which is usually tracked by monetary managers to decide the fate of policy rates, kept declining in November. However, the quantum of fall reduced substantially - with trimmed core that fell from 15.5 to 10.6 percent in the first four months of this fiscal year edging just a tad lower by 0.1 percentage point to 10.5 percent in November.
Most of the talks on inflation at the time of slowdown in economic activity are related to the direction of monetary policy. Now in the near absence of non-IMF foreign inflows - U.S coalition support fund and FoDP commitments - the reliance of meeting the governments revenue shortfall and non-flexible expenditure is primarily on the domestic front. And with the ceiling on fiscal borrowing from the central bank, its imperative for fiscal managers to attract domestic funds, hence an attractive yield on government papers.
This explains that even after the decline of 50 basis points in policy rate to 12.5 percent last month, the secondary market yield on 10-year government bond increased by 23 bps, whereas on 1-year paper it declined by just 17 bps between November 24 and December 9. Thus, the coordination of fiscal and monetary policy will make it difficult for the money managers to further ease the discount rate in this fiscal year.
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