Understatement of the rate of inflation

ARTICLE: The rate of inflation, as measured by Consumer Price Index (CPI) with the base year of 2015-16, has been rising and then falling in 2019-20. It was 8.0 percent in July 2019. Thereafter, it rose rapidly to reach a peak of 14.6 percent in January 2020. It has fallen since then to 8.6 percent in June 20.

The new development is that it has risen once again to 9.3 percent in July 20. In fact, on a month-to-month basis the increase is 2.5 percent. This is the largest increase since January 2019, when the CPI with a more recent year as the base year was introduced. It is significant that in January 2020 when the peak year-to-year inflation rate of 14.6 percent was attained, the month-to-month inflation rate was lower at 2.0 percent.

There is a need to answer a number of questions. First, what explains the extraordinary jump in July 2020 on a month-to-month basis? Second, what factors have contributed to the inflation rate of 9.3 percent in July 2020? Third, are there segments of the population who are once again experiencing double-digit inflation? Fourth, is there evidence of some understatement of the rate of inflation by the PBS? Fifth, what is the short-term outlook for inflation in the country?

The month-to-month rate of inflation of 2.5 percent in July 2020 is more than half due to a sharp escalation in food prices, especially of wheat flour, sugar and perishable items like vegetables. The other factor was the escalation in POL prices accounting for over 20 percent of the increase.

Turning to the year-to-year rate of inflation of 9.3 percent in July 2020 the main contributor here again has been food prices, accounting for 64 percent of the rise in the overall price level. The other factors are the inflation in prices of clothing and footwear and housing rent and utilities with shares of 10 percent and 11 percent respectively.

The 'tomato price effect' has been operative once again as was the case in January 2020. From June to July, the price of tomatoes has gone up by 179 percent. This one price has contributed almost 25 percent to the month-to-month rise in the price level. Similarly, the rise in the price of motor fuel is responsible for 31 percent of the jump in the price level in July 2020.

There are, in fact, segments of the population that are experiencing double-digit inflation. The year-to-year inflation rate in the case of the rural population is as high as 11.6 percent as compared to 7.8 percent in urban areas. In the former case, the month-to-month increase is as high as 3 percent. The difference in the rate of inflation of 3.8 percentage points is attributable more to a higher rate of inflation in food prices in rural areas.

The new CPI, with base year of 2015-16, does not present the rate of inflation by income quintile as is done in the case of the Sensitive Price Index. Accordingly, the latter indicates that the overall inflation in 51 basic consumer items was 13.5 percent for the lowest income quintile and 10.1 percent for the top quintile. An estimate has been made of the difference in the rate of inflation in the CPI by income quintile. It is 11.1 percent for the lowest quintile and 8.5 percent for the top quintile. The primary reason for the difference is the substantially higher share of food items in the consumption expenditure of poor households.

The focus next is on whether there has been some understatement of the rate of inflation by the PBS. There are, in fact, two factors which have created a downward bias in the measurement of the rate of inflation.

The first factor is the extraordinarily low rate of inflation reported in housing rent of only 4.3 percent in urban areas and 4.9 percent in rural areas. There is currently an acute shortage in Pakistan of housing of almost 6 million units for achieving a housing density of 3 persons per room. Pressure on housing has been enhanced by the process of rural - urban migration.

Housing rent has the highest weight in the CPI of 19.2 percent in the urban areas and 8.5 percent in rural areas. The inconsistency arises when the CPI with the base year of 2007-08 reveals higher increase in housing rents. It is very difficult to accept that housing rents are rising by only 4 to 5 percent currently. There is also a need for PBS to indicate how it is measuring housing rents. It is likely that if housing rents had been properly surveyed and reported the overall inflation rate would have been higher by almost one percentage point.

The second anomaly is the divergence reported between the rate of inflation in price of motor fuel and the cost of transport services. The former is reported to have increased by 27 percent while the latter is shown to have fallen by 7.6 percent despite the big increase in the price of motor fuel. Removal of this anomaly could also raise the overall inflation rate by over 0.4 percentage points.

Therefore, the underlying rate of inflation in the CPI is close to 11 percent. The problem is that rising unemployment due to the COVID-19 is taking place simultaneously with high inflation. The people are, therefore, facing a severe form of 'stagflation'.

The Government has to move expeditiously and forcefully to regulate prices, especially of food items. Hoarding and other malpractices have to be curbed. Simultaneously, there is a need for continuing the process of providing relief to poor people at this difficult time. There will be a need for a second round of cash transfers through the Ehsaas/BISP Program to the 15 million poor families that have already received support in the first round of transfers.

The Government will also need to postpone any further increases in electricity / gas tariffs and POL prices. There is a real risk that if the stagflation persists, we may see a large-scale social breakdown in the country.

(The writer is Professor Emeritus and former Federal Minister)

Copyright Business Recorder, 2020