1. OVERVIEW Inflationary pressures that had been showing visible signs of weakening since the eve of FY06 till the initial two months of FY06, have revealed a slight upsurge during September FY06, particularly in the headline inflation.
Similarly WPI inflation, which has been rising sharply since the start of FY06, continued the uptrend during September 2005. Sensitive price indicator (SPI), however, continued the deceleration, which is visible since July FY06 (see Table 1.1).
More importantly, the underlying inflationary trend in CPI is still declining in terms of various measures of core inflation. Similarly the 12 months moving average of CPI inflation has also witnessed a mild decelerating trend.
The earlier deceleration in the price indices, particularly in CPI and SPI, was due to marginal decline in prices of some important food items including wheat & wheat products, along with the stability recorded in the HRI inflation during the same period.
The September surge in CPI inflation could partly be attributed to the onslaught of Ramadan whose fuller effects are likely to be revealed in the data for October 2005 (see Figure 1.1).Even if this effect is found to be significant, it will be temporary and subside in November 2005.
At the same time, the devastating earth quake that struck a major part of the Northern Pakistan and caused huge damage to life and property, will also probably affect the domestic prices as well. Its impact on prices will largely depend on the nature of temporary shifts in demand in both affected and the unaffected areas.
Besides Ramadan and in the aftermath of the earthquake, continuous rise in oil prices has also become a source of major concern in recent times. Although international market witnessed some decline in the oil prices during September 2005, it is still above the US $60 per barrel mark - the highest ever in nominal terms (see Figure 1.2).High priced oil has placed a serious question mark on the sustainability of the current level of GDP growth in the advanced countries where per capita consumption of oil is very high.
Expensive oil is obviously also a source of major concern for oil importing developing countries like Pakistan. The domestic economy is currently importing more than 70 percent of its liquid fuel requirements from abroad.
Therefore, the current high oil prices have posed considerable threats to the economy, in the shape of rising external account deficits, increasing cost of the domestic production, increased transportation costs and consequent building of inflationary expectations.
Earlier the impact of rising oil prices on CPI inflation was muted due to high food and HRI inflation, however, currently all the price indices are reflecting oil price hike as one of the major sources of the current high inflation (see Figure 1.2).
1.1 CORE INFLATION Core inflation reflects permanent or the persistent part of the overall inflation. For this reason, it is also called underlying inflation. It roughly suggests the future course of overall inflation in an economy; that is why it is important from the point of view of policy making.
State Bank of Pakistan computes core inflation both by the method of exclusion and that of the weighted trimmed mean as well1.
Both the estimates of core inflation have been exhibiting visible deceleration since the start of FY06, however, the deceleration was more pronounced in the core inflation by 20% trimming.
While the current high headline inflation is mainly backed by high food and fuel prices accompanied by high, yet decelerating, HRI (house rent index) inflation; the recent trend of core inflation could mainly be due to the last one (see Figure 1.1.1).
HRI inflation, which had been rising steeply during most part of FY05, became somewhat stable by the close of FY05, while during the first quarter of FY06, HRI has witnessed obvious deceleration. HRI was earlier rising on the back of increased construction activity during FY04 and FY05, due to the accommodative monetary policy of the bank, however, the bank has gradually changed the stance from accommodative to relatively tight monetary policy to check the pace of inflation (see Figure 1.1.2).
The tight monetary policy of the bank has been successful in checking the core inflation.