Inflationary pressures are likely to remain strong through the rest of FY11 since continuation of the IMF program would require additional revenue generation measures and upward adjustments in power tariffs, according to State Bank of Pakistan''''s second quarterly report. The report said that adjustment in power tariff and petroleum prices, besides new tax measures would initially add to inflation.
As such, despite recent moderation in inflation, year-end inflation would be in double digit in current fiscal year. "Flood related supply shocks, rise in global prices and magnetisation of the fiscal deficit already continue to exert pressure on prices, keeping inflation in double digits during first half of FY11", it said. Looking at inflation, the outlook is not heartening and inflation at the end of FY11 will be 14.5-15.5 percent as against the target of 9.5 percent, the report said.
It is important here to make a distinction between administered and non-administered prices: popular perception regarding inflation tends to focus on administered prices (eg retail fuel prices, power tariffs, wheat support price) over which SBP has little control.
However, SBP said that it believes that fiscal slippages and excessive use of central bank financing, which the public correctly sees as printing currency notes, has become increasingly instrumental in price/wage-setting behaviour. It added: "This is where inflationary expectations come into play, in terms of pushing non-administered prices". More simply, the link between SBP financing and non-administered prices is becoming more visible, it said.
Unless, monetary policy can credibly limit government borrowing from SBP, it would be difficult to change inflationary expectations. Furthermore, SBP is aware of the impact of high interest rates on the private sector. In January 2011 monetary policy decision, the SBP had surprised the market by opting to hold rates, the report said.