Inflation forecast: exchange rate depreciation, uncertain global oil prices major risks

The State Bank of Pakistan (SBP) Friday said that recent exchange rate depreciation and uncertain global oil prices are major risks to inflation forecast. According to SBP''s first quarterly report "The State of Pakistan''s Economy", issued here, although some impetus has been building around inflation over the past few months following a recovery in global commodity prices as well as consolidating domestic demand, the headline CPI inflation has moderated to 3.4 percent in Q1FY18 from 3.9 percent in Q1FY17, and 4.6 percent in Q4FY17.
Much of this subdued outcome is attributed to easing food inflation, which more than compensated for the steady increase in non-food inflation. While prices of pulses, fresh vegetables, tomatoes, sugar and wheat remained lower, it was the change in FED structure for cigarettes which contributed the most to falling headline numbers. Excluding this item alone increases the CPI inflation from 3.5 percent last year to 3.8 percent during Q1FY18
Owing to rising domestic demand, underlying inflationary pressures continued to strengthen in the first quarter of FY18 as well. However, adequate supplies of soft commodities, normalization of pulses'' price, and a significant decline in tobacco component restricted the overall growth in CPI.
Similar trends in both the demand and supply side sources are expected in the remaining months of the current fiscal year.
IBA-SBP Consumer Confidence Survey, November 2017 edition, indicates an increase in inflation expectations for the next six months. However, staple food stock from last year, along with gains in agriculture yields in current year''s Kharif crops are nonetheless expected to keep a check on rising demand pressures in CPI, the report said.
Additional drag can come from investments in various manufacturing sectors for capacity expansion. Therefore, average CPI inflation in FY18 would remain below its annual target of 6 percent.
"There are however two major risks to this inflation forecast. First, recent exchange rate depreciation through expectations channel, and after some lag, through the higher imported goods'' price can seep into domestic prices. Second, uncertain global oil price poses both upside and downside risks. Recent developments, however, indicate more upside risks. This is mainly due to agreements between Opec and non-Opec countries to cut oil production, unfavorable effects of political shakeup in Saudi Arabia, and rising tensions in Middle East, coupled with government''s recent behavior and intent on passing on the increase in oil price to domestic consumers," the report said.