While keeping the policy rate aligned with the medium-term inflation target, the State Bank of Pakistan (SBP) has inferred that food was the biggest contributor to inflation in 2020-21.
According to the SBP report titled, ‘The State of Pakistan’s Economy’, the previous fiscal year’s inflation outcome was lower than the SBP’s projection of 11-12 percent at the start of the year. This outcome should be viewed in the context of a shift in regulatory and policy dynamics in the country through the course of the year, explains the report while presenting multiple factors which kept the overall level of inflation high during the year.
These factors, either of temporary and seasonal nature, included:
- supply disruptions in major food items stemming from delayed crop arrivals, speculative activities, and weak commodity management;
- duties and taxes levied/ increased in the Budget 2019-20 on multiple food items including sugar, cigarettes, edible oil, and ghee;
- price adjustments on account of exchange rate depreciation that took place towards the end of 2019-20;
- tighter border management by custom authorities; and
- higher transportation costs following the increase in fuel prices as well as the implementation of the axle-load policy.
As a result, headline inflation posted a sharp increase and clocked in at 10.7 percent in 2020-21 as compared to 6.8 percent in 2019-20. The central bank noted that at the start of the year, temporary pressures on inflation were envisaged on account of revenue-enhancing budgetary measures, the approval of up to 168 percent rise in gas tariffs, higher transportation cost, and the absorption of recent exchange rate depreciation.
Furthermore, although the full-year average for energy inflation remained lower than last year, SBP stated that the administrative prices of energy items increased steadily during July-Jan FY20, as the government passed on the impact of energy sector arrears to end-consumers (in both gas and electricity segments). As a result, headline inflation increased to 14.6 percent YoY in January 2020, taking the year-to-date average inflation to 11.6 percent.
However, the situation in both the food and energy sectors changed significantly from February 2020 onward.
Biggest Source of Inflation
Food inflation not only surged significantly during 2020-21 but was also the major contributor to the overall rise in inflation, explained the central bank. Both perishable and non-perishable food items registered double-digit inflation and the impact of the latter was more persistent.
A crisis-like increase in their prices was observed from Q2 onwards, which stemmed from production shortfall compared to its target and lower procurement of the crop in the previous season by procurement agencies.
Other than wheat, prices of cigarettes, sugar, edible oil and ghee, and pulses also came under pressure during the year. In the case of cigarettes, the significant revision in FED pushed up prices. Similarly, in the case of edible oil and ghee products, the increase in the FED rate from 8.0 percent to 17.0 percent primarily contributed to the higher inflation.
Edible oil refineries were also struggling with rising international prices of palm oil and soybean almost since the beginning of Q2-FY20, which they passed on to end-consumers. Furthermore, the double-digit inflation in sugar can also be at least partially attributed to a steep rise in the rate of sales tax from 8.0 percent to 17.0 percent. In the case of pulses, however, inflationary pressures were largely imported, explained the Bank.
Regarding vegetables, the central bank explains that high temperatures and untimely rains disrupted crop cycles this year, as delayed arrivals exerted temporary price pressures in the market. It is important to mention here that the rise in perishable food prices was not just a domestic phenomenon, but also emerged as a regional concern in the second half of 2019.
Core Inflation Trend
Inflationary pressures stabilized during FY20, especially for urban areas. The considerable alleviation in cost-push pressures in the economy during the year was also a factor. Notably, with the stability in global fuel prices along with the appreciation of the Pakistan Rupee against the US dollar in H1-FY2020-21, domestic prices of key raw materials stabilized in recent months.
Separately, the bank noted that revenue-enhancing measures taken in the FY21 budget also affected goods’ prices:
- inflation in the clothing and footwear group can be attributed to the impact of ending of the zero-rating regime (effectively, imposition of 17 percent GST);
- the rise in steel prices can partly be explained by the imposition of a 17 percent federal excise duty on various steel products; and
- the increase in cement prices reflects the impact of the increase in FED this year.
Energy Inflation Slid
SBP notes in the report that in the year under observation, the energy index posted a 12.7 percent increase during 2020-21, compared to 16.3 percent the previous year. This relative softening was contributed primarily by a fall in prices (deflation) of motor fuel and electricity during the last quarter of 2020-21.
Substantial ease in the electricity inflation was observed, as it rose by only 1.8 percent compared to a significant rise of 11.5 percent during 2019-20, both for urban and rural areas during the same period last year.
In contrast to fuel and electricity, the urban gas prices witnessed the highest rise in the energy group during 2019-20, contributing 0.8 percentage points alone to the total inflation and accounting for around 64 percent of the energy inflation. This was in response to the revision in natural gas prices by the Oil and Gas Regulatory Authority (OGRA) for various consumers, effective from July 1, 2019.
With hindsight, the central bank noted in the report that the Monetary Policy Committee (MPC) held multiple emergency meetings to review the inflation situation and cut interest rates by a cumulative 625 bps within almost three months. This historically unprecedented cut was made possible by a commensurate fall in inflation and monetary policy shifting appropriately toward supporting growth in the wake of the COVID-19 outbreak.