The High Inflation is Coming Back

We are going back to the days of high inflation in the country. This is not good news for the ordinary people who are already suffering due to the price hike. The increase in the prices of petrol products has already made the food and products of everyday use expensive. The new government led by Imran Khan will be forced to take measures to control the increasing fiscal and budget deficits which will cause the high inflation.

The new government will be forced to increase the prices of both electricity and gas for the domestic consumers because the last government did not make the necessary adjustments in the prices. The increase in the prices of gas and electricity will badly affect the budgets of ordinary households. It will also increase the business cost and thus make the products more expensive.

The days of low inflation seems to coming to an end. This July, the year-on-year inflation was registered at 5.8 percent; the highest since October 2014. In the last nearly four years, there have been minor indications of a resurgence in inflation. But this time, there is an unmistakable trend observable across the full spectrum of inflationary measures, showing a sustained resurgence of inflation.

A more robust measure of sustained inflation is called ‘core inflation’. This measure removes the effects of commodities whose prices are volatile due to both seasonality or unpredictable behaviour of international markets. These items include energy and food. Interestingly, for quite some time now, even when the overall inflation has been low, the core inflation (non-food, non-energy) has been stubbornly showing a rising trend. In July, the core inflation was recorded at 7.6 percent YOY – again the highest since October 2014.

Here are two more indicators of this trend.   First, the Sensitive Price Index (SPI), computed on a weekly basis and comprising 54 commodities which have a major impact on households’ budget is also 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 in both YOY and MOM inflation during the year. Both these indices are early-warning signals that further inflation is in store.

There are a number of factors contributing to this new wave of inflation. First, international crude oil prices have risen by more than 60 percent since last July. From $48 per barrel on July 1, 2017, Brent rose to nearly $80 per barrel before sliding back to less than $75 per barrel in more recent days. Analysts are apprehending a significant surge in prices as the date (November) for Iran sanctions approaches. Some have predicted – based on the possible disruption in supplies from Iran, which contributes nearly 2.5 million barrels per day to global supplies that the price will increase to $85 per barrel in the near future.

Second, the recent depreciation in the exchange rate could not have been more ill-timed. The last two adjustments made by the interim government were not even needed. From July 2017, when the rate was Rs104.8 per dollar, to mid-July 2018, the rate has depreciated to an astounding Rs128.50 per dollar or about 23 percent.

There is a great deal of inflation that is in store on account of delays in adjustment of administered prices. Most significant is the price of gas, which the previous government did not adjust for full five years, even when, under the law, this is a straightforward exercise. This was partly justified when oil prices were decreasing, but this justification was over-used.

Ogra has determined a gas price tariff that implies an average increase of 46 percent. More worrying is the adjustment required for domestic consumers, where an increase of 300 percent is determined. The bill of an average consumer paying a monthly cost of Rs400 will rise to Rs1, 200. This will become quite burdensome. In the meanwhile, huge arrears have accrued for both gas supply companies due to delayed adjustment. A sum of Rs300 billion, nearly one percent of GDP, has been determined on this account, which Ogra has asked the companies to recover in installments. This would be an added charge after the increased price.

The increase in electricity prices will have a major impact on overall inflation. The settlement of circular debt will have an impact on inflation as well, as it would inevitably increase the budget deficit.