Vagaries of Consciousness
- The economy is in disarray
The year-on-year (YOY) inflation for the month of June (versus June 2017) was recorded at 5.2pc, the highest during the just closed fiscal year. The average inflation during the year 2017-18 was 3.92pc compared to 4.16pc during 2016-17. Evidently, the more recent rise in YOY inflation has yet to affect the overall inflation. But there are many indications that the recent surge in prices could well be heralding a new wave of high inflation which was abated in 2015 after it ravaged the economy for nearly seven years.
The month-on-month (MOM) inflation for June was up 0.6pc over May. Similarly, the numbers for the months of May, April and March, over their previous months, were 0.5pc, 1.8pc and 0.3pc, respectively. Clearly, a rising trend is visible in monthly inflation even if we normalise the exceptional increase of 1.8pc. There are other indications supporting the apprehension of building inflationary pressures.
A more robust measure of inflation is called the ‘core inflation’. This measure removes the effects of such commodities whose prices are volatile both for seasonality and uncertainty about international prices. These items include energy and food. Even though the overall inflation has been low, the core inflation (non-food, non-energy) has been stubbornly showing a rising trend. It was recorded at 7.1pc YOY, again highest during the year. The YOY core inflation was 5.5pc in July 2017 and steadily increased to 7.1pc in June 2018. This clearly shows that a great deal of pent-up inflation may be ready to release.
Two more pointers support our thesis. First, the Sensitive Price Index (SPI), computed on a weekly basis and comprising 54 commodities having a major impact on households budget is showing a rising trend since March 2018. Second, the Wholesale Price Index (WPI), comprising commodities used as inputs in various industries, has shown a rising trend both in YOY as well as MOM inflation during the year. Both these indices are early warning signals for inflation in store.
Inflation undoubtedly reflects unfavorable external conditions but more significantly the mismanagement practiced in the last two years
What factors are giving rise to evolving inflationary pressures? First, the key factor that has contributed to price stability in the last four years is moving in the wrong direction: international price of oil. The Brent price has increased from less than $48 (per barrel) on 6 July 2017 to a high of $80 before sliding back to around $78 on 5 July, an increase of 63pc. Leading banks are predicting that oil would hit around $85 closer to the days when Iranian sanctions go into effect, as its present supplies of 2.5 million barrels per day would drop at least by one million barrels. The US president has requested Saudi Arabia to bridge the gap though the uncertainty remains.
The second factor is the exchange rate that has already seen a sizable depreciation. In July 2017, the exchange rate was Rs104.8/$ and has closed the fiscal year at Rs121.70/$, though it briefly touched Rs125/$ also. In three episodes of depreciation the exchange rate has reached this level. This adds up to a 16pc depreciation and, as we would point out later, there is no certainty if we have reached a stable level. Now taken together – oil price increase and rupee depreciation – we have a harmful combination of factors that would impact inflation in the broadest manner. It may very likely be spiraling, as there are secondary effects when these pivotal prices get absorbed in the prices of other goods and services and those begin to increase. In fact, one get an alibi to pass on perhaps more than the justified increase in those prices such as transporters.
While the oil price increase is not under the control of a small country like Pakistan, the battering of the exchange rate is our own making. The fiscal deficit for the year is projected at 7.1pc of GDP or Rs.2450 billion compared to budget target of 4.1pc or Rs1480 billion during 2017-18, highest since 2012. Consequently, the balance of payments deficit has shot up to 6pc of GDP or $18 billion, highest in more than a decade. In 2016-17, a similar breakdown of macroeconomic framework had occurred, when the fiscal deficit shot up to 5.8pc after it was brought down to 4.3pc from 8.2pc during 2013-16 under the IMF program. The BOP deficit also shot up to 4pc from an average of about 1pc in the program period.
It would be hard to find another example in country’s economic history when macroeconomic conditions have deteriorated so sharply as they have in the last two years. In some ways, we may now be worse off than we were back in 2013. So long as this situation is not corrected, we may have to get prepared for a long spell of inflation such as the one found in 2008-2013, when the average inflation was 12pc, which would mostly hurt the poor and fixed income groups.
We see even more alarming developments having an impact on prices. An issue that has been brewing for quite some time has finally come to the fore. OGRA has determined the gas price tariff that means an average increase of 46pc. For nearly five years, the previous government had delayed the revision in gas price taking the plea that the international oil prices were declining. This was partly justified but not as long as it has been delayed. The price hike would be nearly unbearable for the domestic consumers, where the required increase is worked out at 300pc. To appreciate what it would mean, take an average consumer paying a monthly bill of Rs450. The consumer would face a revised bill of Rs1350/. This would be quite burdensome. There are others sectors that would also face high price increases, most significantly power sector, captive power, fertiliser (non-feedstock) and commercial, all of which would lead to secondary effects on consumer prices.
In the meanwhile huge arrears have emerged for both utility companies and need for price adjustment was urgent. A sum of Rs300 billion, nearly 1pc of GDP, has been determined on this account, which OGRA has asked them to recover in installments. This would be an added charge after the increased price. Some have raised the issue that such costs should not be recovered from those consumers who were not connected to the system when such arrears were accumulated for otherwise they would be paying for something they have not benefited from.
Finally, the electricity prices, which were lower on account of negative fuel adjustment charge are on the rise even though the full impact has yet to come. The increase in electricity prices would have a major impact on overall inflation. The settlement of circular debt would have an impact on inflation as well, as it would inevitably increase the budget deficit.
The economy is in disarray. Inflation undoubtedly reflects unfavorable external conditions but more significantly the mismanagement practiced in the last two years. The challenges have multiplied and the new government would face a very rough and overheated economy in great need of calm and cooling, immediately.