State Bank of Pakistan (SBP) expects inflation to remain in the range of 7.5 to 8.5 percent during FY15, in line with the government's target of 8.0 percent. According to SBP's annual report, the stability in international commodity prices especially oil should help achieve this target. There are, however, certain upside risks from perishable food prices, following the recent floods and a possible upward adjustment in administered prices.
More specifically: "The government has agreed with the IMF to reduce power subsidies by Rs 60 billion in FY15. This would require an 11 percent power tariff hike for all categories of consumers in October 2014. "The FY15 Budget has proposed a collection of Rs 145 billion through Gas Infrastructure Development Cess (GIDC), which is significantly higher than Rs 88 billion collected in FY14. This would require an upward adjustment of 25 percent in piped-gas tariffs in January 2015.
"The recent flooding in Punjab, Sindh and Kashmir could create supply constraints for perishable food items, which will have a strong, albeit temporary, impact on headline CPI. The IBA-SBP's Consumer Confidence Survey (for September 2014) also indicates higher inflationary expectations for the months ahead. "While overall commodity prices remain soft in the global market, crude oil prices could become volatile with regional disturbances in the Middle East. However, with the US once again the largest oil producer in the world, oil price forecasts remain soft in FY15. "Finally, the ongoing political challenges in Pakistan could spark hoarding and price hikes. Although the impact of the political demonstrations is difficult to quantify, it has dampened investor confidence, disrupted normal import/export operations, and created pressures on the PKR, which are likely to impact inflation in FY15."
Meanwhile, the inflation outcome in FY14 was far better than State Bank of Pakistan's initial expectations due to a downward revision in retail POL prices in November 2013, partially offsetting the impact of the October 2013 increase in utility tariffs, the unanticipated appreciation of the PKR in late March largely compensated for the impact of depreciation during July-November, and soft oil and palm oil prices coupled with a stable PKR, provided a credible anchor that pulled down inflationary expectations and the resulting price-setting behaviour of commercial businesses.
With hindsight, SBP's initial projection of 11-12 percent for FY14 was much higher than the actual CPI inflation of 8.6 percent for FY14. In fact, SBP assumed the upward adjustment in administered prices and the depreciation of the PKR during initial months of FY14 would persist, which have a critical impact on likely inflation and inflationary expectations.
Not surprisingly, therefore, SBP's initial projections exceeded the annual target of 8.0 percent, and the realised inflation of 7.4 percent in the previous year. Predictably, headline inflation did pick up and reached 10.9 percent in November 2013, from 5.9 percent in June 2013. However, the major contribution came from the unexpected rise in prices of perishable food items and wheat. The second half of FY14 proved more favourable as: (a) the government reduced retail POL prices in November 2013, in response to softening oil prices in the global market; (b) the PKR appreciated after depreciating sharply during Jul-Nov; and (c) the supply of wheat and perishable food items improved, which countered the increase in H1-FY14. These developments, along with the lagged impact of monetary tightening, kept inflation and inflationary expectations in check for rest of the year. The non-food-non-energy (NFNE) inflation declined to 8.3 percent in FY14, from 9.6 percent in the previous year.
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