Declining inflation: Realty or window dressing?
Although Pakistan has seen a decline in inflation, with essential commodity prices falling in recent weeks, these reductions have done little to alleviate the financial strain on the population.
Wages remain stagnant, and a wave of job losses, particularly in the textile industry, has worsened economic conditions. Inflation, as measured by the Sensitive Price Indicator (SPI) and Consumer Price Index (CPI), has dropped to multi-year lows, yet the underlying economic pressure continues to mount, with rising taxes and an unstable employment market fueling concerns over the country’s financial stability.
The prices of essential goods in Pakistan have seen a decline, but they remain high in comparison to stagnant wages and the significant job losses experienced in recent months. The growing concern over unemployment is particularly pressing as a large number of textile mills have shut down, with more closures anticipated.
Pakistan’s weekly inflation measure, the Sensitive Price Indicator (SPI), dropped to a three-year low of 14.07% for the week ending on September 5, 2024, compared to the same period last year. On a week-to-week basis, inflation slowed by 0.15%, primarily due to reduced energy and food prices. This marks the fourth consecutive week of deceleration in essential commodity prices, according to data from the Pakistan Bureau of Statistics (PBS).
In addition to the decline in the SPI, the Consumer Price Index (CPI)-based inflation also dropped to a single-digit rate of 9.6% in August 2024—the first time in three years. This has sparked speculation that the State Bank of Pakistan (SBP) might cut its policy rate for the third time in its upcoming monetary policy meeting. Financial markets are expecting the central bank to lower the rate by 1-1.5 percentage points, which could provide a much-needed stimulus for economic growth.
Previously, the SBP had reduced the policy rate by a total of 2.5 percentage points in June and July, bringing it down to 19.5%. Despite these cuts, the real interest rate (policy rate minus CPI inflation) remains high at nearly 10%. The business community is calling for a more substantial reduction of up to five percentage points to support the struggling economy.
In August, Pakistan’s CPI inflation rose by 9.6% year-on-year, marking a 34-month low. Urban inflation increased by 11.7%, while rural inflation stood at 6.7%. This continues a downward trend, as inflation had previously risen by 11.1% in July and 12.6% in June 2024.
Meanwhile, global rating agency Moody’s upgraded Pakistan’s local and foreign currency issuer and senior unsecured debt ratings from Caa3 to Caa2. This upgrade reflects Pakistan’s improving macroeconomic conditions, with moderately better liquidity and external positions, although challenges remain significant.
According to PBS, the August CPI of 9.6% represents a 1.5% decline from July’s figure of 11.1%. Core inflation (excluding food and energy) also decreased from 11.7% in July to 10.2% in August, aligning with the overall CPI drop.
Since May 2024, a notable trend has emerged in the calculation of CPI (Consumer Price Index) and core inflation: the difference between the two has narrowed to less than a percentage point, indicating that imported inflation has been minimal, with the bulk of the inflationary pressure coming from domestic factors.
Economists argue, however, that inflation is understated by at least 3 to 4 percentage points. This is due in part to the greater weight given to prices in rural markets compared to metropolitan centers, and in part to the inclusion of subsidized Utility Store prices, where many essential items are either out of stock or of poor quality, particularly wheat. Despite this, the data reflects a downward trend in both CPI and core inflation.
Imported inflation is typically driven by the rupee-dollar exchange rate, which has remained stable, contributing to the decline in CPI. However, there are two major concerns not fully accounted for in the CPI calculation. First, significant tax increases in the current year’s budget—especially on the salaried class and sales tax—have pushed total tax revenues up by 40%, from 9.25 trillion rupees last year to a projected 12.97 trillion rupees.
This substantial rise in taxes means a sharp reduction in household income, leading to reduced consumer spending and lower aggregate demand. Consequently, the quality of life for many workers has deteriorated, which explains the poverty rate increase to 41% last year. Meanwhile, foreign reserves stood at $9.2 billion as of August 16, 2024, yet the government still fell $2 billion short of its budgeted external funding and is now actively seeking pledges. Additionally, it is pursuing $4 billion in foreign commercial bank loans, which come with high interest rates and short repayment terms, increasing debt servicing costs and contributing to a growing fiscal deficit—a highly inflationary policy.
The decline in core inflation has placed pressure on the State Bank of Pakistan (SBP) to reconsider its current high discount rate of 19.5%, which is 9.9 percentage points above CPI, a metric introduced by Reza Baqir during his tenure as governor, and 9.3 percentage points above core inflation, a standard benchmark for most central banks.
The key question is whether the SBP’s Monetary Policy Committee will be able to reduce the discount rate in its next meeting. This decision may be influenced by the International Monetary Fund (IMF), whose loan approval is still pending. All agreed prior conditions from the staff-level agreement, reached on July 12, 2024, have yet to be fully met. A high discount rate may either remain a condition for approval or become an additional requirement for IMF Board approval and subsequent tranche disbursement.
While inflation is declining, the real value of income continues to shrink due to higher taxes, leading to growing public discontent. To address these issues, the government must improve its leverage with the IMF by reducing current expenditures, targeting subsidies more effectively—focusing on beneficiaries of the Benazir Income Support Programme—and avoiding further tax hikes on an already burdened populace.
While the decline in inflation offers some respite, it is overshadowed by the shrinking real incomes of the public, driven by higher taxes and stagnant wages. The burden on households is growing, with poverty rates on the rise. To navigate this crisis, the government must reduce current expenditures, better target subsidies, and work to ease the tax burden on an already strained population. This would not only improve public sentiment but also strengthen the country’s leverage in international negotiations, particularly with the IMF, as it seeks to stabilize its fragile economy.