Dramatic decline in inflation faces various challenges

The current drop in Pakistan’s inflation rate from 29.2% in November 2023 to 4.9% in November 2024 is a remarkable achievement, highlighting significant improvements in the country’s economy. This dramatic reduction can be attributed to several key factors, mainly the reduction in prices of non-perishable food items and the influence of high base prices from the previous year. Food and beverages, gas prices, and transport and fuel are key contributors to the decline. The most significant drop in inflation has been seen in the food and beverage sector, particularly in non-perishable food items. Staples like wheat flour, rice, milk, sugar, and tea went through sharp price reductions. For case in point, wheat flour prices dropped by 32.5%, mainly due to a bumper crop and some issues with procurement processes. These price reductions have likely had a particularly beneficial impact on lower-income households. The housing, rent, and utilities sectors also experienced a notable decline, especially in gas prices. After a massive 520% rise in gas prices last year, they only increased by 10% this year, contributing significantly to the reduction in overall inflation. This sharp contrast is due to the base effect of last year’s high prices. Another important factor in easing inflation was the reduction in motor fuel prices. This was primarily driven by the stability of international oil prices and a slight appreciation of the Pakistani rupee post-November 2023. These changes helped reduce transportation costs, which contributed to overall inflation relief. Despite the positive trends, the sustainability of this low inflation rate is uncertain. Several risks and challenges could reverse the current trend. The main concern for the latter part of 2024 is the potential for inflation to rise due to a low-base effect. Since inflation has been comparatively low in the recent months, the comparison period in the coming months could result in higher inflation rates. As prices stabilize or rise, the annual inflation comparison might shift, leading to an uptick. Pakistan’s relationship with the IMF remains critical. If the country fails to meet the performance criteria set by the IMF for the ongoing program, inflation expectations could rise, leading to a reduction in external financial inflows. This would put pressure on the rupee and increase the cost of imported goods, similar to the inflationary spiral seen in 2022-2023. The rising circular debt in Pakistan’s power sector could lead to higher electricity tariffs. This would directly push up inflation, especially in the energy sector, and further strain household budgets. Additionally, if the government struggles to meet its revenue targets, it might resort to increasing indirect taxes, which could also fuel inflationary pressures. A growing budget deficit could force the government to increase the money supply, which is a typical catalyst for inflation. The balancing act between fiscal policy and inflation control will be critical in maintaining price stability. Looking forward, inflation in Pakistan is projected to rise from 4.9% in November 2024 to an average of 8.5% for the fiscal year 2024-2025. The IMF’s projection for the same period is higher at 9.5%, with inflation potentially reaching 10.6% during the second half of the fiscal year (from December 2024 to June 2025). While the inflation rate is likely to remain in single digits, this represents a significant increase from the current levels. While the dramatic decline in inflation over the past year is a positive development for Pakistan’s economy, various challenges loom on the horizon that could push inflation higher in the near future. Key risks include government fiscal policies, global factors like oil prices, and the successful completion of the IMF program. The coming months will be crucial in determining whether these positive trends can be sustained.