Inflation Eases to 4.1% in December: Economic Outlook and Future Policy Directions

In December 2024, inflation in Pakistan saw a significant reduction, easing to 4.1%, a trend that provides the government and the central bank with more space to address monetary policy. This slowdown in inflation is expected to offer the State Bank of Pakistan (SBP) the flexibility to reduce the policy rate without negatively impacting the fiscal and external sector balance.

Current Inflation Trends and Government Expectations

The Pakistan Bureau of Statistics (PBS) recently reported that the inflation, measured by the Consumer Price Index (CPI), further decelerated to 4.1% in December 2024 compared to the same period last year. This decrease is consistent with the government’s expectations, although it is lower than the central bank’s forecast. The SBP had predicted a slight increase in inflation due to the phasing out of base effects, but the actual data has proven more favorable than anticipated.

This inflationary slowdown has brought about more optimism for economic stability. The Ministry of Finance had earlier indicated that inflation could remain in the range of 4-5% for the coming months, which aligns with the newly reported data.

Government’s Inflation Target for Fiscal Year 2024

The government of Pakistan has set an inflation target of 12% for the fiscal year 2024, a figure that may now be more attainable given the recent inflationary slowdown. On the other hand, the International Monetary Fund (IMF) has projected inflation to be around 9.5% for the same period. Inflation for the first half of the fiscal year (July-December 2024) stood at an average of 7.2%, significantly lower than the government’s target.

This favorable inflation trend offers a silver lining for policymakers who are grappling with the challenges of stabilizing the country’s economy. The easing inflation rate gives the SBP room to further cut interest rates, which have already been reduced from 22% to 13%. However, further reduction could be warranted, especially since inflation is still far from the 12% target set for the fiscal year.

Inflation Breakdown: Urban vs. Rural Areas

One of the most noticeable impacts of the inflation slowdown was the disparity in the urban and rural areas. In urban centers, inflation fell to 4.4%, driven primarily by a decline in food and energy prices. The overall cost of living in cities was tempered, particularly as energy and food prices eased.

In rural areas, inflation slowed down to 3.6%. This figure is also attributed to a reduction in food inflation, particularly the prices of essential food items. However, the price dynamics in rural regions were still impacted by the prices of perishable food items such as onions, vegetables, and fruits, which saw price hikes ranging from 11% to 44%.

Core Inflation Insights

Core inflation, which excludes volatile items like energy and food, has also shown signs of easing. Core inflation in cities dropped to 8.1%, while in rural areas, it stood at 10.7%. This reduction in core inflation is encouraging for the central bank, which typically uses core inflation as an indicator when making policy decisions. The average core inflation now stands approximately 4% lower than the policy rate, which may encourage the central bank to lower the policy rate further.

Economic Impacts on Businesses and Growth

While inflation has slowed, the real challenge lies in Pakistan’s economic growth, which registered a meager 0.92% during the first quarter of the fiscal year. This sluggish growth is largely due to the high cost of doing business and inconsistent economic policies that have negatively impacted industrial output.

Businesses are calling for stimulus measures such as reductions in energy costs, stabilization of policy frameworks, and more consistent economic reforms. The high interest rates continue to hinder business expansion, and until interest rates come down to single digits, it is unlikely that businesses will experience significant growth.

SBP’s Policy Rate and Future Expectations

The State Bank of Pakistan has already reduced the policy rate by 9 percentage points, from 22% to 13%, but experts believe that further cuts are possible. Core inflation rates, which are now much lower than the current policy rate, leave room for a potential rate reduction. The upcoming monetary policy meeting later this month will likely address these possibilities.

Further cuts in the interest rate will be a welcomed move for businesses that have struggled under high financing costs. However, these cuts must be balanced carefully to avoid destabilizing fiscal and external sector factors, especially given the country’s reliance on imports and the IMF’s oversight of Pakistan’s fiscal policy.

Challenges in Tax Collection and Revenue Generation

The slow pace of inflation and the sluggish growth in large-scale industries have also contributed to weak revenue generation by the Federal Board of Revenue (FBR). The FBR had set its revenue collection targets based on an anticipated 16% GDP growth, but the nominal GDP is growing at a much slower pace of about 8%. This discrepancy has caused a shortfall of approximately Rs386 billion in tax collection.

One of the key reasons for this shortfall is the slowdown in inflation, which has dampened the revenue from sales taxes and other indirect taxes. In addition, a lack of effective enforcement by the FBR has contributed to the failure to meet revenue targets. As a result, the government is struggling to balance fiscal expenditures with revenue inflows, which could result in increased borrowing or cuts in government spending.

Impact on the Cost of Living and Essential Goods

Despite the overall reduction in inflation, certain categories of goods continue to see significant price hikes. Food inflation, in particular, showed an increase of 2.5% in cities, primarily due to the surge in prices of perishable items like onions, tomatoes, and vegetables. Rural areas, however, experienced deflation in food prices, with a reduction of about 0.5%.

The government has also faced challenges in managing the agricultural sector. The premature withdrawal of agricultural support prices has led to a 34% drop in wheat prices, which has impacted flour prices as well. This reduction in agricultural support has left farmers vulnerable to price volatility, which has, in turn, impacted the overall food inflation rate.

Conclusion: Room for Policy Adjustments

The easing of inflation to 4.1% provides policymakers in Pakistan with a unique opportunity to further reduce the policy rate without jeopardizing fiscal and external sector stability. The central bank will have to carefully weigh the risks of further rate cuts against the potential benefits of stimulating business growth and enhancing consumer purchasing power.

In the coming months, businesses, consumers, and policymakers alike will be watching closely to see how the government and the SBP navigate this delicate balance between inflation control, economic growth, and fiscal responsibility. Given the uncertainty surrounding global economic conditions, the next few months will be critical for Pakistan’s economic stability.

FAQs

1. Why has inflation eased to 4.1% in December?
Inflation has eased primarily due to a reduction in food and energy prices, as well as a favorable base effect from the previous year.

2. How does the easing of inflation impact the State Bank of Pakistan’s policy rate?
The reduction in inflation provides the SBP with room to cut the policy rate further, which could stimulate business activity and reduce the cost of borrowing.

3. What is the government’s inflation target for the current fiscal year?
The government has set an inflation target of 12% for the fiscal year, but current trends suggest that it could be lower.

4. How does inflation vary between urban and rural areas?
Urban areas saw a slowdown in inflation to 4.4%, while rural areas experienced a larger reduction, with inflation dropping to 3.6%.

5. How does core inflation impact economic policy decisions?
Core inflation, which excludes volatile food and energy prices, is an important indicator for the central bank. A lower core inflation rate suggests that the SBP can afford to reduce interest rates further without fueling inflation.