3 Price Trends

3.1 Overview

The long-term deceleration in the annualized Consumer Price Index (CPI) inflation, visible over the last five years, continued into FY03 (see Figure 3.1); CPI inflation dropped sharply through the period to reach 3.1 percent by end-June 2003 - the lowest level for the last three decades.

 

Table 3.1: Inflation Trends

 

 

 

At first sight, the other important inflation indices do not clearly reinforce this picture (see Table 3.1), depicting a small pickup in inflationary pressures during FY03 relative to the preceding fiscal year. Specifically, the Sensitive Price Indicator (SPI), which provides information on prices of selected essential items, manifested a marginal increase, while the Wholesale Price Index (WPI) and the GDP deflator both depicted slightly stronger increases in inflationary pressures during FY03.

 

However, it is important to note that the higher annual WPI inflation is largely contributed by the rise in energy prices during the first eight months of FY03 (see Section

3.2 for details). Thereafter, the marginal WPI inflation too, has declined steadily (see Figure 3.2), and seems likely to continue this trend in the months ahead. This suggests that even the higher WPI inflation in FY03 is not inconsistent with the deceleration in CPI inflation for the period.

 

Table 3.2: GDP Deflator - Sectoral

 

 

The relatively higher GDP deflator for FY03 is mainly contributed by the commodity-producing sector, as inflationary pressures clearly seem to have declined in the services sector. Within the commodity-producing sector, the largest contribution to inflationary pressures is from the agri-sector, which appears consistent with the price developments in the sector (see Table 3.2).

 

It is also interesting to note that for the first time over a decade the trend of the annual CPI inflation has differed from that of the GDP deflator during FY03. One possible explanation is that CPI better captures the impact of imported inflation/deflation (it is probable that imported deflationary pressures significantly impacted the domestic prices during FY03 as the rupee gained strength). More importantly, the relative weakness in Consumer Price Index -(CPI) inflation is probably also a function of the decline in real private consumption evident in the National Income Accounts. It should be noted that the impact of decline would be muted in the GDP deflator due to the strong jump in the net export and investment activities.

 

All in all therefore, the inflationary pressures seem to be trending downward, as the marginal rate,¹ for all three indices, the benchmark CPI, the WPI and the SPI, is lower than the average annual rate, recording lows of 1.9 percent, 4.4 percent and 3.5 percent respectively.

 

The continued deceleration in marginal inflation rates, despite the exceptionally strong monetary expansion, appears to reflect the influence of positive supply-side factors as well as subdued private consumption demand.² Specifically, the following factors have contributed in containing inflationary pressures during FY03:

1)            The recovery by both the agricultural sector and manufacturing sector, which probably had a favorable effect on availabilities and relative prices of some commodities;

 

2)     The appreciating rupee that would reduce production costs by lowering input prices in rupee terms. The deflationary impact of the rupee appreciation, in some cases, has been compounded by low international prices (this is particularly evident for food imports -see Figure 3.3);

 

3)     A decline in interest rates to historical low, contributing to lower financing charges and working capital cost, thus easing pressure on upward price movements of goods produced.

 

In light of the above, the downtrend in domestic inflation needs to be carefully monitored going forward. It is unclear at this point if the lack of inflationary pressure in FY03, despite sustained growth in monetary aggregates, is simply because of: (1) lags in the transmission mechanism; (2) a weakening of the relationship between monetary aggregates and inflation as a result of the financial sector liberalization (which would argue that the SBP shift towards an inflation targeting regime); or else, (3) is a harbinger of a deflationary trend.

 

3.2 Consumer Price Index (CPI)

 

While both food and non-food components of inflation saw a visible decline during FY03, it was the former that witnessed a sharper fall. As a result, it was non-food inflation that made the larger contribution to the annualized CPI inflation of 3.1 during the period (see Figure 3.4 & Table 3.3).

If the volatile components, i.e. food and energy, are excluded, the CPI inflation shows the lowest increase of only 1.2 percent (see Figure 3.5). In fact, the quarterly SBP forecast indicate that barring exceptional shocks the benchmark CPI inflation will continued to decelerate in the months ahead towards 2.4 to 2.8 percent range during FY04.

 Table 3.3: Contribution In Inflation

 

Withinfood items, the prices for 45 items either declined or recorded no change thus offsetting the contribution of other items recorded increases in their prices during FY03 (see Table 3.4). Amongst the essential items, which recorded significant decline in their prices, included potatoes, pulses, sugar, gur, onion, milk powder (loose) and tea.

 

Thus, most of the (lower) food inflation during FY03 stems from substantial increases in the prices of relatively fewer items, which carry higher weights in the CPI basket. These include key staples such as wheat and wheat flour with a combined weightage of approximately 7 percent (which saw price increases of 4.6 percent and approximately 3.0 percent respectively) as well as cooking oil and ghee (that saw double digit price hikes). Similarly, the prices of some other essential items i.e., rice, beef, mutton, chicken & eggs (farms) and milk fresh also witnessed sharp increases.

 

 Table 3.4: Distribution of Price Changes of Items of CPI Basket - FY03