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The headline inflation stood at 5.7 percent in Jan 21 – lowest level (since Jun 18) in the PTI government so far. The prices are now stabilizing at higher levels. The prices in consumer basket increased by 23 percent and food prices index by 31 percent since the PTI government assumed power. That is too much of an increase in 2.5 years. The nominal increase in wages is low – implying that the real wages are on decline.

Certainly, this low monthly inflation number is not something to jubilate over. Part of the inflation in the last 2.5 years is contributed to economic stabilization – such as inevitable currency depreciation. But part of it is due to poor governance and overly zealous government involvement in decision making – such as increase in food prices.

Now stabilization is achieved and economy is on a recovery track. The focus over the next 2.5 years should be to work on improving wages by facilitating economic growth. The government performance can be judged after five years, based on real wage growth – increase in wages relative to inflation.

In Jan, the CPI index is down by 0.2 percent from the previous month. The low yearly number is attributed to high base effect in Jan 20. The CPI was up by 14.6 percent back then – highest inflation number in the PTI government, and the monthly increase was of 2 percent. In Jan 21, monthly decline of 0.2 percent along with higher base is resulting in lowest inflation number in 2.5 years.

Numbers are deceptive, and one can spin any story that is desirable based on them. It is best to have perspective.

The good omen is that over the last two months, the CPI index is falling. The decline is more visible in food prices – within it the rural food prices dip is more pronounced. The monthly rural food inflation down by 3.4 percent in Dec 20 and 2.2 percent in Jan 21. The decline in urban is 2.1 percent both in Dec and Jan.

Since rising food prices were driving headline, now the decline is taming the inflation. The gap between the rural and urban inflation is thinning as well. The gap was 4.3 percent in Oct-20 and now it’s at 1.6 percent - rural at 6.6 percent and urban at 5.0 percent. This is healthy.

The food prices are now settling at higher base. There are signs of stability in these. The non-perishable food items – such as wheat and sugar, may not see the crazy increase as was witnessed in the last two years. The perishable food items – such as tomatoes, onions etc, are reverting to a new mean. The decline in perishable food items in Jan (over precious month) is at 21.3 percent. In fact, the non-perishable items prices are marginally up – sugar by 14.6 percent and wheat by 8.2 percent.

The house rent index (computed every fourth month) is up by 2.0 percent over the previous recording in Oct 20. On yearly basis, this is up by 4.8 percent. It has a weight of 20 percent in CPI and is the biggest contributor to core inflation. Subdued house rent index is keeping core inflation tamed. It’s down to 5.4 percent for urban and marginal up to 7.8 percent for rural. The decline in core inflation was visible in the past few months; but now the number seems to be bottoming out. On monthly basis, the urban core inflation is up by 0.9 percent and rural by 1.1 percent.

The 7MFY21 average inflation is standing at 8.3 percent. The full year inflation is likely to be in range of 8.8.5 percent (SBP estimates are 7-9%). Based on this, the real interest rates are in 1-1.5 percent negative. The SBP expects medium term inflation at 5-7 percent. But the inflation may inch up in the Apr-Jun 21 quarter (may touch double digits) due to low base effect.

The upward pressure on inflation will emanate from increase in international oil (and other commodity) prices and electricity prices upward revision. There are no demand pressures as such seeing as output gap is negative and there are no signs of wage-price spiral. Seeing all these factors, 1-2 percent increase in policy rate in next 6-18 months cannot be ruled out.