The consumer price index is up by 2.9 percent in FY16, which is a 13-year low. Dar is ecstatic on this achievement as lady luck is with him. The prime reason for subdued inflation in FY16 is the supply side positive shock - low commodity prices, especially oil and food items.
But the party will be over soon! The recent trends suggest that inflationary pressures are surging up; there are both cost push and demand pull factors in play. On the supply side, the oil prices after touching nadir in January 2016, are on the rise now; currently they are at the levels which were last seen in Jul-Sep period last year.
However, the impact of high prices is not yet visible on the CPI as the government has been holding back price increase by reducing the taxation on petroleum product; there is no price change for both diesel and petrol for four straight months despite the fact that oil prices are consistently rising. The caveat is that little or no room is left for further GST adjustment, and the government has no option but to pass on the impact if oil prices continue to head north in July as well.
With the government absorbing oil price hike; the supply side inflation is visible in food items. An immediate impact is usually observed in perishable food items that have increased by 17 percent from sub index's trough in February 2016.
Overall food prices are up by 3.3 percent in the last four months. But the fall in food prices prior to February was too sharp, and that is why the increase in food prices is not being depicted in food prices index, which is up by mere 1.24 percent in June 16 over the same period last year. Items like tomatoes (42%), Onion (31%) and chicken (20%) have substantiality decreased in the entire year, though there is an upward pressure on the prices of these items lately.
On the flipside, prices of pulses and grams have significantly increased (around 40%) of late. Ironically, it is not worrying for our Finance Minister, who has suggested low middle income people to graduate to rich man's food - chicken curry and all. Who cares about the multiple adverse effects of consuming too much of broiler chicken on health, especially growing kids.
The picture is not too bright on the demand side as well. The central bank started an easing cycle from November 2014 and it continues to date - the policy rate has reduced from 10 percent to 6.25 percent in the process.
The impact of low rates is already visible on monetary demand - The real M2 growth of 9.5 percent (nominal M2 minus CPI) in April 2016 was almost double of the provisional real GDP growth of 4.7 percent in FY16. This clearly shows that the gap in demand and actual growth is too high, and one of the two, GDP growth or inflation has to pick up to attain equilibrium. The real GDP growth is optimistically targeted at 5.7 percent in FY17, which implies that inflation may start picking up soon.
The real estate prices have skyrocketed in the last year or two, which usually is the case in the era of low interest rates. Improved security situation in Karachi and higher taxation on non-filers have also contributed to the boom in real estate, especially in urban areas. In CPI, which is computed based on surveys in urban centers only, the impact of real estate prices is usually captured in house rent index. However, a modest increase of five percent in the sub index suggests that either the impact is not yet visible in rents, or there is something wrong in the computation of house rent index. BR Research fears that latter is the case due to which, the overall CPI is understated by one percentage point.
There are pressures on inflation whichever way one may analyze. The current account has posted a hefty deficit of $792 million in May 2016 due to higher oil and machinery import bill, which may continue to increase in months to come. On the export side, the recent fall in Pound Sterling and Euro would have its toll on our exports as Pak rupee continues to be artificially pegged to USD.
Any pressure on currency would have its impact on inflation invariably; However, Dar is trying his best to keep the currency sticky. But for how long? Eventually the bubble will burst, and that would surely be the end of low inflationary era!
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