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Various price indices have risen exponentially in recent weeks. This trend is best revealed by the movement of the Sensitive Price Index (SPI) in the last two months. During the first week of March, it has risen on a year-to-year basis by as much as 15 percent. A month ago, it was under 8 percent and two months ago below 6 percent.

Similarly, the Consumer Price Index (CPI) showed a rate of inflation of 5.7 percent in January 2021. It has risen to 8.7 percent in February and there is the prospect of a further increase in March 21, as indicated by the SPI in the first week of March. Simultaneously, the Wholesale Price Index had a rate of inflation of 6.4 percent in January and 9.5 percent in February, after a long time rising faster than the CPI. This implies that the latter index will show a bigger increase after a lag.

Why is this happening? What is the likely trend in coming months? Are there any policy measures that could negate this galloping tendency in the rate of inflation? What role can a born again SBP with vastly greater autonomy play in arresting this trend?

The first analysis undertaken is to determine why the increase in the CPI jumped up from 5.7 percent in January to 8.7 percent in February? There are two factors responsible for this increase in the rate of inflation. First, there was a quantum jump in electricity tariffs of 47 percent on average for domestic consumers. The weight in the CPI of electricity charges is 4.6 percent. Therefore, the contribution to the three percent increase in the index is two-thirds by one price, the domestic electricity tariff. This is unprecedented.

Second, there continues to be relatively high inflation in food prices of almost 9 percent in February, as compared to 6.7 percent in January. However, the pattern of inflation in food prices is different this time. Earlier, inflation was concentrated in the prices of perishable food items, especially vegetables. For example, in February 2020 the prices of potato, onion and tomato had gone up by as much as 83 percent, 103 percent and 61 percent, respectively, in urban areas. However, in February this year they have actually fallen by 5 percent to 30 percent.

Instead, food price inflation is now concentrated in non-perishable items. The prices in February 2021 show an overall increase of 13 percent in these items. The biggest jump has been recorded is of 48 percent, which is in the price of eggs, followed by 36 percent in the price of chicken and 14 percent in the price of milk. Sugar continues to become more expensive with a rise in price of 17 percent and wheat flour has recorded a price increase of 14 percent.

There are two obvious underestimates of inflation which have kept the rise in the CPI in February still below 10 percent. The first is housing rent which is shown to have increased by even less than 5 percent and with an unchanged rate for many months now. This is extremely low given the large and growing housing shortage in the country. In the past few years, housing rents generally rose faster than the overall rate of inflation, but apparently this is not the case now. The expenditure on housing rent has the largest weight among all the items in the CPI, with a weight exceeding 19 percent. Therefore, any understatement in the rate of increase in housing rent leads to a significantly lower estimate of the overall rate of inflation in the CPI. Second, medicine prices, according to Pakistan Bureau of Statistics (PBS), have risen by only 8 percent. This is completely contrary to the reality.

There is a need to explain the persistence of high rates of inflation since 2018-19. Obvious reasons are the precipitate drop in the value of the rupee, supply shortages of key essential items, rise in import prices in US$, hike in energy prices and alleged cartelization in the market for goods like sugar and wheat.

However, what has not been adequately emphasized is the role of monetary factors. First, high interest rates that prevailed up to February 2020 before the Covid-19 attack were expected to control aggregate demand but instead had a cost-push impact on prices. Second, monetary expansion has been very rapid and fueled primarily by a big escalation in the size of the budget deficit. In 2017-18, money supply, M2, grew by a modest rate of 10 percent. This increased to 18 percent in 2019-20 and is currently rising also by almost 18 percent.

What then is the outlook for inflation in coming months? First, the international oil price has risen to $68 per barrel from below $48 per barrel in December 2020. The government has not transferred the impact on the retail prices by a big reduction in the Petroleum Levy on HSD oil and Motor Spirit. It has been brought down from Rs 30 per litre to Rs 16.35 per litre in the case of Motor Spirit and to Rs 15.65 per litre in the case of HSD oil. Already, the implied revenues loss for the rest of the financial year is Rs 80 billion. Given the pressure to raise more revenues and contain the fiscal deficit especially after the reactivation of the IMF Programme it is unlikely that the Petroleum Levy will be cut anymore. Consequently, retail prices of petroleum products will start increasing with both direct and indirect impacts on the rate of inflation.

Second, prices of many other commodities are also rising as the world economy revives following the widespread use of vaccines. The landed price of imported wheat has approached Rs 2,060 per maund in February. This is over 25 percent higher than the procurement price being offered to farmers in Punjab. Similarly, the prices of palm oil, pulses, spices and raw cotton have gone up by 35, 20, 6 and 10 percent, respectively.

Third, there has been an upsurge in the price of cloth and garments to 11 percent in February as compared to less than 9 percent at the start of the year. The rate of increase is likely to accelerate as production of textiles gets affected by the limited availability of cotton and yarn due to the catastrophic cotton crop failure. Cloth and garments have a weight of 7 percent in the CPI and escalation in their prices could have a significant impact on the overall rate of inflation.

Fourth, the prices of perishable food items have been falling sharply. It is not clear how long this trend will persist. They could start rising once again as was the case in the corresponding period of 2019-20.

This brings us finally to the prospect of a changed role of the SBP following the granting of substantially greater autonomy after the passage of fundamental amendments to its Act. Apparently, the focus will then be almost exclusively on inflationary targeting.

The last Monetary Policy Statement contains a projection by the SBP that the inflation rate will remain within the range of 7 to 9 percent in FY21 and trend towards 5-7 percent over the medium run. Given the emphasis now on inflationary targeting it will be of importance to see if the SBP is successful in ensuring that these projections are realized. However, there remains the underlying risk given the above factors that inflation could approach a double-digit rate.

(The writer is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2021