December 31, 2020 (MLN): Pakistan’s headline inflation for the month of December 2020, is likely to ease-off further despite the increase in fuel prices and housing index.

By gathering the projections put forth by various brokerage houses, the inflation is expected to clock in at around 7.92%-8.1% with an average estimate of 8.03% YoY compared to 8.35%YoY in the last month and 12.63%YoY in December 2019. Moreover, the Ministry of Finance in its monthly economic outlook also forecasted headline inflation for the month of Dec’20 to fall within a range of 7.8 and 8.3 percent.

This would bring 6MFY21 average inflation to 8.64% as against 11.42% in the corresponding period last year. To note, this is within the range of SBP’s inflation forecast of 7% – 9% during FY21.

On monthly basis, the inflation is expected to decline with an average estimate of 0.03% MoM compared to the inflation of 0.82% MoM in November 2020.

The expected deceleration in the cost of living is driven by falling prices of perishable food items. Running through the weekly SPI data published by the Pakistan Bureau of Statistics (PBS), among major food items, the prices of Potatoes, Tomatoes, and Onions are expected to register the most decrease. Moreover, with wheat and sugar being imported in order to meet the demand, the prices of these products are expected to come down as well.

On the flip side, the transport group index is expected to witness an uptick on account of a surge in fuel prices by 1.74% MoM in December’20 compared to petroleum prices in Nov’20. This was the result of a decline in USDPKR parity by 550bps in Dec’20 along with the rise in international Arab light prices which jumped by the current 14% MoM to average prices of USD 48.96/bbl compared to USD 43/bbl recorded in the previous month.

In addition to this, the rise in costs of shelter, clothing, and education is also expected to partially offset the impact of tamed food inflation by pushing CPI towards the north.

INFLATION OUTLOOK:

As the year 2020 touching its end, inflation fear is a perennial topic of conversation for the economists at the beginning of each new year and the year 2021 is no exception.

Since March 2020, when the economy had faltered under the effects of the Covid-19 pandemic, with economic activity ending, the SBP came up with the most aggressive central bank in terms of a rate cut as it reduced 625 bps since March-2020 from 13.25% to 7%. After reducing the policy rate by 625bps from March to June due to COVID induced slowdown, the focus of the SBP remained more on financial stability rather than inflation as it maintained the status quo and kept the interest rate unchanged at 7% for the rest of the months of CY2020 to stimulate aggregate demand and employment in the aftermath of COVID-induced lockdown.

SBP’s view on inflation outlook remained encouraging during the period as the higher base effect, relatively lower international oil prices, a reversal in volatile food prices, and subdued aggregate demand negated the fear of an overheating economy. To note, during 5MFY21, headline inflation stood at 8.76% which was within the range of SBP’s inflation forecast of 7-9% for FY21.

Going forward, the headline inflation is expected to retard further in the coming months on account of tamed food inflation on the back of smooth supply and favorable base effect. However, a pickup in domestic demand and the impact of an increase in international oil prices pose an upside risk to inflation expectations. Furthermore, the resumption of the IMF program by the end of FY21, also likely to bring an uptick in inflation numbers due to its condition to raise the electricity and gas tariffs in order to curtail the circular debt. This would compel SBP to raise the interest rate going forward. 

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