Estimate of average inflation: Stable food prices, consumer confidence causes for SBP’s revision

Impact of improving macroeconomic indicators exceeds expectations.

KARACHI:

Following the ill-timed prediction by the State Bank of Pakistan (SBP) last November that the Consumer Price Index (CPI) would stay at an ‘elevated level’ of 10.5%-11.5%, inflationary pressures immediately tapered off in December, and headline inflation has remained in single digits thus far.

No wonder the central bank had to revise its estimate of the average inflation for 2013-14 downward to 8.5%-9.5% in the recently released quarterly review report. The CPI inflation for the first six months of 2013-14 remained 8.9% compared with 8.3% recorded in the first half of 2012-13.

The SBP is not alone when it comes to revising inflation expectations. Many brokerage houses had pointed to an imminent drop in the headline inflation figure estimates for the current fiscal year even before the central bank realised the impact of improving macroeconomic indicators.

In a research note issued before the release of the SBP report on March 28, Invest Capital Markets told its clients that the CPI was likely to remain close to 8.5% for 2013-14. Indeed, the reasons for the downward revision of the headline inflation estimate are more than one.

Stability in food prices

Recent stability in the prices of food items seems to have contributed a great deal in the SBP’s expectation of a muted inflation outlook. The fact that year-on-year food inflation remained 7.04% in February was reason enough for the SBP to bring down its annual inflation estimate by 200 basis points.

The weight of food and non-alcoholic beverages in the CPI index is 34.83%, which is the largest among all constituting groups. Non-perishable food items, whose weight in the index is 29.84%, increased in February by only 6.9% on an annual basis, further cementing the view that inflation will remain at a lower-than-expected level going forward.

Moreover, the SBP anticipates that global commodity prices will remain subdued in coming months, with the impact of imported inflation and exchange rate pass through to play a favourable role.

Rising consumer confidence

Besides solid statistical evidence, consumer’s sentiments about the economy also play a critical role in determining the inflation outlook. According to the Consumer Confidence and Inflation Expectations Survey – conducted jointly by the SBP and the Institute of Business Administration, Karachi – the percentage of households expecting a rise in overall prices in the next six months decreased from 52.43% in November to 49.48% in March.

The softening of inflationary expectations is on account of stability in administered prices, in particular retail oil prices, and the rupee appreciation against the dollar, according to the SBP.

Persisting risks

Although there is enough data to suggest that the headline inflation will remain in the single digits for 2013-14, the CPI Index may witness an uptick in case the government announces a hike in gas tariffs that were expected to roll out during January.

The SBP believes the ‘needed’ upward revision in gas tariffs will put pressure on inflation, as household gas rates have 1.57% weight in the CPI Index.

Moreover, the central bank’s quarterly report highlights the possibility that the government may not be able to achieve the wheat procurement target, thus causing wheat flour inflation in the second half of the fiscal year.

The government has maintained the wheat support price at the last year’s level of Rs1,200 per 40 kilograms, although its current market price hovers around Rs1,600 per 40 kilograms. This may lead to the failure of the government to build up its stocks, paving the way for cost-push inflation in the economy.

Published in The Express Tribune, March 30^th, 2014.

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