After 7 months, inflation sees a dip. But is it a cause for celebration?

While the improvement in headline YoY numbers is eye-catching, they are primarily based on a statistical artifact

In the midst of back breaking inflation, there seemed to be some good news on the offing on Monday when it was revealed that the rate of inflation in the country had fallen month on month in June 2023.

So what is going on and is this a cause for celebration? The federal government and finance minister Ishaq Dar would have you believe so.

Fall in inflation and its reasons

The latest data released by the Pakistan Bureau of Statistics (PBS) for June 2023 showed that inflation clocked in at 29.4 percent year-on-year compared to 21.3 percent in June 2022. This is the lowest annual increase in prices in some months, with January 2023 inflation recorded at 27.6 percent.

On a month-on-month basis, inflation declined to -0.3 percent. 

Experts have attributed this decline to two main factors: the stabilization of the US dollar and a decrease in commodity prices. The food group, which holds a substantial weight of 34.58% in the inflation reading, remained a major driver behind the decrease, with a 1% fall in June 2023 compared to May 2023.

“While the improvement in these headline year-on-year numbers is eye-catching, they are primarily based on a statistical artifact: there had been an extreme jump in price levels in June last year,” Dr Ali Hasanain, associate professor of economics at the Lahore University of Management Sciences (LUMS), told Profit

“The May YoY inflation increase reported a larger jump because prices in May last year had been lower; in contrast, the June YoY increase is smaller because June last year already had much higher prices. This is reflected in the more muted decrease in inflation (-0.3%) reported in month-on-month terms,” he explained. 

This is what is called a high base effect. To put it into perspective, the CPI figures for May and June 2021 were 145.24 and 144.82, respectively. Compare this to 2022 when CPI for May was 165.23, whereas the figure for June was 175.71. 

In 2023, the CPI figures for May and June stood at 227.96 and 227.37, respectively. So, May 2023 (figure) compares to May 2022 (figure) and June 2023 to June 2022. 

Since inflation compares the CPI figure for any given month to the same month of the previous year, ignoring or misunderstanding the base effect can lead to erroneous conclusions.

Dr Hasanain said the government would be well-advised to manage expectations carefully. 

“First, prices in the economy are still rising faster than they have risen in years – excluding the even worse numbers of the last four months. This is the time to roll up our sleeves and fix this crisis, not to celebrate.

“Second, having reached a deal late last week to enter into a nine-month IMF Stand-by Agreement (SBA) and with a subsequent program all but certain to be necessary, the government cannot afford to provide short-term ‘relief’ at the expense of macroeconomic fundamentals.”

The first signs of this “increased discipline” were seen on Friday, when Dar announced that the tax on petrol would be increased slightly (leaving prices unchanged), diesel prices would be raised (without a change in taxes), and that electricity tariffs were likely to see an increase during the ongoing month, Dr Hasanain said. 

“These measures are important for staunching the bleeding of the country’s finances in the short-term, but will likely impact inflation in the months ahead.

“Broader reforms improving efficiency are crucial to lighten the burden of ever-higher prices for the country’s citizens. It is time that the government shift the agenda away from short-term movements in isolated indicators, and ask to be judged on progress in fixing skewed industrial incentives, power sector leakages, the broken tax and customs machinery, and other fundamental, productivity-determining facets of the economy. Only then will we start turning the corner,” he added. 

Rural and urban disparity

Rural and urban inflation figures have also shown some variations. In urban areas, CPI inflation stood at 27.3% on a year-on-year basis in June 2023, as opposed to 35.1% in the previous month and 19.8% in June 2022. On a month-on-month basis, it increased by 0.1% in June 2023, compared to an increase of 1.5% in the previous month and 6.2% in June 2022.

Meanwhile, CPI inflation in rural areas registered at 32.4% on a year-on-year basis in June 2023, compared to 42.2% in the previous month and 23.6% in June 2022. On a month-on-month basis, rural inflation decreased to 0.8% in June 2023, compared to an increase of 1.7% in the previous month and 6.6% in June 2022.

Economic Situation and IMF Agreement:

The decline in inflation comes as welcome news for Pakistan, a country grappling with various economic challenges. Pakistan has faced a perceived default risk and experienced a downgrade by international rating agencies, reflecting the state of its economy. Political turmoil and frequent changes in key leadership have added to the nation’s woes.

However, there is a glimmer of hope as Pakistan has achieved a significant breakthrough by securing a staff-level agreement on a new nine-month, $3-billion stand-by arrangement. This agreement was announced on Friday and is currently subject to approval by the IMF Executive Board, with consideration expected by mid-July.

The deal is being seen as a major achievement for the Pakistani government, which has been striving to secure the ninth review of its previous bailout program while attempting to attract foreign investment amid dwindling foreign exchange reserves.

In response to the challenging economic conditions, the State Bank of Pakistan (SBP) Monetary Policy Committee (MPC) raised the key policy rate by 100 basis points (bps) to 22% after an emergency meeting last week. The SBP stated that the upward revisions in taxes, duties, and PDL rate in the FY24 budget, along with the withdrawal of import restrictions, have slightly deteriorated the inflation outlook and could potentially increase pressure on the already stressed external account.

Despite the challenges, the recent decline in CPI-based inflation offers some hope for Pakistan’s economic recovery. The government’s focus on securing international financial support and implementing necessary economic reforms will be crucial in stabilizing the country’s economy in the long term.

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