Pakistan’s economy is projected to experience significant relief from inflation in early 2025, with the Consumer Price Index (CPI) expected to drop to 3.06% in January. This marks the lowest inflation rate in almost nine years, offering hope for economic recovery. The sharp decline contrasts sharply with January 2024, when inflation peaked at 29.7%, creating a stark difference in the nation’s inflationary trend.

Key Factors Behind the Drop in Inflation

The significant drop in inflation can be attributed to various factors, including a favorable base effect, PKR stability, and subdued food and energy prices. Experts from Arif Habib Limited (AHL) have cited these reasons for the anticipated decline, making it a noteworthy shift in the inflation trajectory.

Base Effect Impact on Inflation

One of the critical drivers behind the drop in inflation is the base effect. In January 2024, Pakistan witnessed a record high of 29.7% inflation, largely due to the aftermath of a severe currency depreciation and fuel price hikes. This led to inflated price levels last year, which now create a low baseline for January 2025, contributing to the downward shift in inflation figures.

PKR Stability Contributing to Lower Inflation

The stability of the Pakistani Rupee (PKR) has played a vital role in easing inflationary pressures. After facing severe depreciation over the past year, the stabilization of the PKR has helped contain the rise in import costs, which are a significant factor in the nation’s overall inflation levels.

Subdued Food and Energy Prices

Subdued food and energy prices have also had a positive impact on the inflation outlook for Pakistan. The prices of basic food items such as wheat, sugar, and vegetables have remained stable, and global oil prices have also witnessed a slowdown in their upward movement. This trend has resulted in lesser pressure on household budgets and reduced inflationary concerns.

Projections for Inflation in the Coming Months

While the first quarter of 2025 (Q1CY25) promises to maintain low inflation levels, experts foresee an uptick in inflation by mid-year. Projections suggest that inflation will stay below 5% until April 2025, mainly due to the continuation of the favorable base effect.

Inflation Expected to Rise Post-April 2025

As the base effect fades, inflation is expected to gradually rise starting May 2025, reaching an estimated 8.81% in May and 8.97% in June. This increase is due to the effects of high inflation in the same months the previous year, which will no longer be factored into the base.

Full-Year Inflation Forecast

Looking ahead to the full fiscal year (FY) 2025, analysts project the average inflation to settle around 6.5%. This is based on assumptions such as stable global oil prices and a gradual depreciation of the PKR. However, the possibility of fuel price adjustments and changes in energy tariffs could introduce volatility into the inflation trajectory.

Interest Rates and Policy Adjustments

Given the projected decline in inflation, analysts expect the State Bank of Pakistan (SBP) to consider reducing interest rates in their upcoming monetary policy review. The real interest rate is expected to remain high at nearly 9.98% in January 2025, well above the historical average of 2.5%. This significant real interest rate offers room for a 100-basis-point (bps) cut, potentially lowering the policy rate to 12%.

Expected Impact of Rate Cut

The anticipated rate cut aims to support Pakistan’s macroeconomic stability by aligning monetary policy with the improving inflation situation. With inflation projected to decline in the first half of 2025, a rate cut could stimulate economic activity by lowering borrowing costs and encouraging investment.

Risks to Inflation Forecasts

Although the outlook for inflation is generally positive, several risks could affect the trajectory:

1. PKR Depreciation: A sharp depreciation of the PKR could increase the cost of imports, putting upward pressure on inflation, particularly for food and energy.
2. Global Oil Prices: Any significant rise in global oil prices could lead to higher energy costs, affecting transportation and manufacturing, which in turn could fuel inflation.
3. Government Policies: Changes in tax policies, such as the increase in Petroleum Development Levy (PDL) or the removal of a GST hike, could have unintended consequences on inflation.

Conclusion

In conclusion, Pakistan’s inflation outlook is expected to show considerable improvement, with a forecasted drop to 3.06% in January 2025. The nation’s economic resilience, supported by a stable PKR, favorable base effects, and subdued food and energy prices, should help maintain this positive trend in the short term. However, analysts warn that inflation may rise again later in the year as the base effect fades.

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Frequently Asked Questions (FAQs)

1. What is the base effect in inflation forecasting?

The base effect refers to the impact that the previous year’s inflation figures have on the current year’s inflation rate. A high inflation rate in the past year creates a lower base for comparison, which often leads to a lower inflation rate the following year.

2. How does the PKR stability affect inflation?

When the Pakistani Rupee stabilizes, it reduces the cost of imports, particularly oil and food items. This helps keep inflation in check by preventing imported goods from becoming more expensive.

3. What is the projected inflation rate for 2025?

Analysts project that inflation will remain below 5% until April 2025, after which it may rise to around 8.81% in May and 8.97% in June. Full-year inflation is expected to average 6.5%.

4. How does global oil price fluctuation affect inflation in Pakistan?

Rising global oil prices directly impact transportation and manufacturing costs in Pakistan, leading to higher prices for goods and services, which can contribute to inflation.

5. Will the SBP cut interest rates in 2025?

Given the expected decrease in inflation, analysts predict that the State Bank of Pakistan (SBP) will cut its policy rate by 100 basis points in its January 2025 monetary policy meeting.

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