The last time monthly double digits CPI was in Nov 13 (10.9%) – 5 months into the PMLN tenure. In July 19, the headline inflation clocked at 10.3 percent – a monthly increase of 2.3 percent. The CPI is computed on old methodology (new is due), and the number was supposed to be high, but still the methodology flaws resulted in headline inflation even higher than expectations.
The measures in new budget increase in energy tariffs and petroleum prices were the reasons for expected hike in CPI; but the house rent index surprised the analysts’ community once again as the sub index measurement came in higher than anticipated. There is some jump in core inflation as well, but not proportionate to the CPI increase – core increase from 7.2 percent in June to 7.8 percent in July (trimmed core from 7.3% to 8.0%) while CPI jumped from 8.9 percent to 10.3 percent.
The biggest contributors to CPI increase are house, water, electricity and fuel (up by monthly 4%, and yearly 12.7%), and transport (up by monthly 3.9%, and yearly 14.7%) while the food inflation increased by 7.9 percent (monthly 1%). Within house rent and utilities sub index (CPI weight:29.4%), the gas prices are (wrongly) up by 30.9 percent (see today’s column titled: CPI – Correction time for PBS, again!) monthly and the electricity prices increased by 2.63 percent. These were on the cards and were incorporated in the forecasts.
What surprised a few that is yet again a counterintuitive jump in house rent index. The house rent is computed once in a quarter and in Apr-Jul the sub index increased by 1.86 percent (yearly - 6.2%). With real estate prices in distress, it does not make sense to see such a hike in house rent. In April 2018, when all of the sudden house rent rose by 3.1 percent on quarterly basis, the outlook of the inflation was changed for next twelve months due to high base effect. The house rent is computed based on simple average of rent computed in 40 cities which is implying the weight of Karachi average rent is same as the rent in a small town of Balochistan.
Later, in Oct 18, increase in gas prices (based on simple averages to slabs) further increased the upward bias to CPI outlook till Sep19. That is why inflation is expected to peak in Sep19, before slowly started tapering off. The inflation is likely to peak around 11-12 percent in Sep19 and the full year average may hover around 9-10 percent. The central bank policy rate is at 13.25 percent which is implying a real interest rate of around 3 percent - enough to keep inflation in check.
However, the increase in interest rates and currency depreciation is beyond the inflationary consequences and overall macroeconomic equilibrium. The objective is to curtail the current account deficit to manageable levels. The CAD came down from $19.9 billion (6.3% of GDP) in FY18 to $13.6 billion (4.8%) of GDP in FY19. The IMF is projecting it to fall to $6.7 billion (2.6%) of GDP in FY20. The demand curbing policies may continue till the fall in CAD starts showing desired results.
In that case, further stress in currency, can push CPI up, and that could lead to further increase in interest rates. However, that might not be the right strategy as this will chock the economy further and would have adverse fiscal implications – higher debt servicing and low tax revenues collection.