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On inflation and its core

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November 8, 2021 (MLN): Obtuse social media commentary from the ruling party aside, ordinary Pakistani is being crushed under the weight of inflation. Elevated food and energy prices have forced people to cut down their travel, reduce food expenditure, and decrease electricity as well as now gas consumption.

The causes of these are discussed in the mainstream media almost every day. From international commodity price shocks to witch-hunts against retailers and supply chain and procurement mismanagement by the government are some of the few causes that are on the tip of the tongue.

But what many seem to be missing is the trend in core inflation. Simply put, core inflation is the change in prices of goods and services minus the food and energy. Core inflation is used by economists (including those at the International Monetary Fund) to understand prices since it essentially excludes the more volatile food and energy categories.

Food and energy prices are volatile since these are traded on a daily basis in local as well as international markets and are influenced by various factors. The current commodity boom is a consequence of a sharp revival in the global economic rebound from Covid-19. These prices are usually non-sticky and tend to move downwards after a rally to settle at an equilibrium.

The same has been the case with Pakistan. Average food inflation during FY22, FY21 and FY20 (July-October period) has remained at 9.4%YoY, 13.3%YoY and 16.52%YoY respectively, gradually easing into a moderate range.

However, reasons for increases in FY21 and FY22 include exchange rate depreciation (making food imports costlier), closing of border trade with India (since a large part of the local tomato, potato and other essential items’ shortages were met through imports), supply chain mismanagement (theft from government-maintained reserves), increase in minimum support price of major crops (a political move to lure rural voter base) and hoarding by middlemen (private sector players).

Meanwhile, Pakistan’s core inflation or non-food non-energy (NFNE) inflation (as called by the Pakistan Bureau of Statistics) during July-October FY22 period has averaged at 6.55%YoY. Over a longer horizon, average core inflation during the last 38 months has averaged at 7.17%. Core inflation in FY22 is lower than its historical average. These numbers suggest that movements in NFNE items have remained well within the historical average.

Urban and rural core inflation converged at 6.7%YoY in October. However, on one hand, core inflation in rural regions has fallen from its peak of 9.4%YoY in February 2020 to 6.7%YoY in October 2021, urban core inflation has risen from its trough of 5.3%YoY in June 2020 to 6.7%YoY in October 2021. The increase in core prices from urban areas is mainly because high energy (MS, HSD and FO) and utility prices (revisions in electricity base tariffs) are slowly but surely feeding into core prices. However, since rural areas lack urban services and do not entail travelling on daily basis, the core in a rural region has normalized and fallen to its historical range.

Core inflation which essentially includes housing, education, entertainment, services, transport and communication usually see a lagged impact of rising energy and fuel prices. However, core inflation tends to be sticky in nature thereby a persistent increase in prices of core items worries economists.

It is worth discussing CPI inflation and its effect on the masses, policymakers are unlikely to pay much heed to headline numbers affected by cyclical and seasonal changes. Fuel and food prices are non-sticky and are definitely going to come down once global demand-supply mismatches and local issues such as procurement, hoarding is resolved, bringing down the headline numbers.

However, the important metric is core inflation which remains well within the historical range and policymakers will be unfazed unless it shows sharp movement upwards.

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Posted on: 2021-11-08T15:54:06+05:00