Inflation remains in the limelight

Review 2009Inflation remained in the limelight throughout the year as the rise in prices globally witnessed during most part of 2008, saw a dramatic reversal in trend by late August and continued to decline further in 2009. A sequence of global shocks, beginning with the international financial crisis leading to a fall in consumer confidence, caused commodity prices to plunge world over. Falling inflation changed the landscape of the global economy, allowing policymakers to focus on revitalising growth by easing key interest rates and stimulating demand. Central bankers in developed countries are convinced that inflation could be a threat as recession is cooling down especially in the world largest consumer economy, the US.Pakistan is still experiencing double-digit inflation. The surge in food and commodity prices witnessed during the start of fiscal year 2008-09 pushed the Consumer Price Index (CPI) in Pakistan to a rerecord level of 25.3 per cent in August 2008, remaining above the 20 per cent level until February 2009. The country entered into IMF stabilisation programmes in November 2008 in a bid to revive a struggling economy as all major macroeconomic indicators, including inflation, were at precarious levels. Despite marginal decrease in April 2009, the rigid declining nature shown by the inflation rate during the year remained a major cause for concern and could be attributed to a host of factors. While the food group was the primary source of inflation in Pakistan during 2009, the non-food component of the CPI has also been persistently high, resulting in the overall stubbornness of the inflation rate. More detailed analysis shows that within the food group, a smaller group of items had a much higher contribution to a sharp pick up in prices.On the other hand the non-food component also remained in double-digit throughout the year 2008-09, owing to the transport group, fuel and lighting group and the house rent index remaining at elevated levels. The house rent index in particular, which makes up a considerable 223.4 per cent of the total CPI, has been steadily increasing over the past two years, mainly on account of the methodology used to calculate it. Other factors such as the withdrawal of petroleum and gas subsidies and the rationalisation of electricity tariffs; imported inflation and exchange rate depreciation of the rupee against the dollar; excessive government borrowing from the central bank to help finance the fiscal deficit; the levying of custom duty on various imports in order to curtail imports, increase in the support prices of some major crops like wheat and sugarcane; supply-side structural issues and mismanagement; speculation, smuggling and hoarding of goods; political unrest and a deteriorating law and order situation have all hampered government efforts to stabilise prices domestically in CY09.The core inflation, which is measured by removing volatile items such as food and energy and makes up 51 per cent of the total CPI, has also seen an upward trend during the current fiscal year. Within core inflation, the house rent index contributes a substantial amount which is why it has remained resolute for the most part of FY08-09. Inflation and SBP viewThe year 2009 was a challenging year for SBP in terms of achieving its prime objective of price stability. Due to the deteriorating domestic macroeconomic imbalances, worsening global economy, and rising international commodity prices, inflation rose to its historic high levels. Bringing inflation down was an uphill task given the rising expenditures on account of domestic political situation and meager domestic resources. Availability of foreign resources was uncertain due to the global downturn and subdued foreign investors' interest. The weakening of the economic conditions also led to turbulence in the financial markets resulting in severe liquidity shortages in both the money and foreign exchange markets. In these circumstances, SBP endeavored to contain inflation more aggressively with policy rate hikes and took corrective actions to ease the liquidity conditions in the financial markets. Moreover, SBP decided for more frequent reviews of the economy. Later on, when towards the end to the first half of FY09, the economy started to pick a positive turn and the outlook of the economy appeared encouraging, SBP reviewed its policy and decided not to continue with further tightening of monetary policy. By the end of third quarter of FY09, the macroeconomic situation improved further and allowed the SBP to initiate an easing of monetary policy. The year culminated with a significant improvement in the fiscal deficit and external current account deficit and a substantial reduction in inflation. Foreign exchange reserves have once again reached to a decent level and confidence in the economy appears to be improving. While addressing the economic issues, SBP also focused on improving its capacity to handle the ever changing economic environment and emerging policy challenges. In this regard, it took a number of steps during the year. First, to improve vigilance of the economy, SBP increased the frequency of issuing monetary policy statements from bi-annual to quarterly basis. Second, the decision making process was further streamlined by regular meetings of the Monetary Policy Committee. Third, decision making was made more prudent and forward looking by supporting it with improved information content, analysis of economic developments, and forecasts of key macroeconomic indicators. Further, to improve the effectiveness of monetary policy, the decision making responsibility regarding the cut off rate for T-bills auction was transferred to the Ministry of Finance. This step allows a clear signalling of the monetary policy stance and communicates the market separation of its debt and monetary management functions. More recently, SBP has also introduced an interest rate corridor of 300 bps below the policy discount rate to make the transmission mechanism more effective.Current Inflation as explained by FBS The CPI, SPI and WPI based inflation rates in 2009-10 increased by 10.26 per cent, 9.03 per cent and 3.44 per cent over 2008-09 respectively. CPI, SPI and WPI in 2008-09 increased by 24.65 per cent, 32.05 per cent and 30.12 per cent respectively over 2007-08 and in 2007-08 the CPI, SPI and WPI increased by 7.85 per cent, 10.87 per cent and 9.88 per cent respectively over 2006-07. An analysis of data for three years for the same period indicates that SPI and WPI in 2009-10 were lower as compared to last two years but CPI was higher in 2008-09 as compared to 2007-08.The inflation rates based on CPI, SPI and WPI in November 2009 increased by 10.51 per cent, 10.75 per cent and 12.46 per cent over November 2008 respectively. CPI, SPI and WPI in November, 2008 increased by 24.68 per cent, 29.79 per cent and 19.87 per cent respectively over November, 2007 and in November, 2007 the CPI, SPI and WPI increased by 8.67 per cent, 11.01 per cent and 12.64 per cent respectively over November, 2006. An analysis of data for three years for the same period indicates that SPI and WPI in November, 2009 were lower as compared to last two years except CPI which was higher in 2008-09 as compared to November, 2007.The inflation rates based on CPI, SPI and WPI in November, 2009 increased by 1.39 per cent, 2.49 per cent and 2.78 per cent over October, 2009 respectively. During November, 2008 CPI, SPI and WPI decreased by 0.12 per cent, 1.35 per cent and 5.11 per cent over October, 2008 and CPI, SPI and WPI in November, 2007 increased by 0.14 per cent, 0.85 per cent and 1.63 per cent over October, 2007 respectively. The Consumer Price Index of November, 2009 has increased by 1.39 per cent over October, 2009, and increased by 10.51 per cent over corresponding month of last year.The average SPI of November, 2009 increased at 2.49 per cent over October, 2009 for the lowest income group, while it also increased by 1.94 per cent in case of all income groups combined.The wholesale price index of November, 2009 increased by 2.78 per cent over October, 2009. It increased by 12.46 per cent over the corresponding month of last year.Although the country missed quarterly budget deficit target but it was praised by IMF for inflation-fighting efforts, to cut inflation rate to 10.5 per cent from 25 per cent in November 2008.Fund has approved about 11.3 billion dollars of stand-by loan, of which 6.54 billion dollars has been disbursed with Tuesday's additional trench of 1.2 billion dollars.Global Scenario Falling production in commodities from rice to milk is bad news for everyone except investors. Rice may surge 63 per cent to 1,038 dollars a metric tonnr from 638 dollars owing to Philippine imports and a shortage in India, a Bloomberg survey of importers, exporters and analysts showed. The US government says nonfat dry milk may jump 39 per cent next year, and JP Morgan Chase and Co. forecasts a 25 per cent gain for sugar. Global food costs jumped seven per cent in November, the highest since February 2008, four months before reaching a record, according to the United Nations Food and Agriculture Organisation. Farm prices this year lagged behind copper futures that doubled and oil's 57 per cent increase. A recovery from the worst recession since World War II would spur food demand and boost costs for buyers of commodities including milk processor Dean Foods Co. while increasing the number of hungry people that the UN says now exceeds one billion. "Agricultural commodities will be a great investment in the next three to five years," said Oliver Kratz, who manages 10 billion dollars as head of Global Thematic Strategy investments at Deutsche Bank AG's DB Advisors in New York, including three billion dollars in agriculture. For those who can't afford to pay more for food, there's the 'painful' risk of hunger, he said. Expanding populations and higher incomes are boosting consumption in China and India. China's milk demand is recovering after domestic supplies were tainted with melamine, a chemical used in making plastics that killed at least six babies and sickened almost 300,000 children. Droughts in India and Argentina and typhoons in the Philippines have reduced output. Future InflationMuzzammil Aslam, an economist at JS Global Capital Limited wrote in their report "2009: Macro, politics and the market" that the Inflation for FY10 is expected to be around 10 per cent because of stable international oil prices; we expect oil prices to average 67 dollars/bbl in FY10. As far as food price inflation is concerned, we do not expect any major upside, as most of the local grain prices are trading inline with the international prices. On a positive note, core inflation is continuing to display a downward trend and came in at 10.6 per cent, from a peak of 18.9 per cent reported in February 2009."In sum, we believe, Pakistan's economic downturn is bottoming out, growth is expected to revive and deficits are likely to be contained which will keep the inflation and the exchange rate stable. On the liquidity front, Pakistan is likely to get flows from the IMF, the US under the Kerry-Lugar Act, and the Coalition Support Fund. These flows from the Friends of Pakistan, China and Saudi Arabia are likely to add on to the liquidity, and hence it will provide room to the government to expend on infrastructure development projects. We continue to expect Pakistan's government to consult the IMF on the country's macro management, while micro management will be scrutinized under the Kerry-Lugar Law" he added.