Unprecedented food inflation will compound Pakistan’s economic challenges
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Throughout history, wars have resulted in economic shocks that impact countries well beyond those directly involved, and in ways that are difficult to predict. The Arab–Israeli Yom Kippur war of 1973 precipitated huge increases in oil prices, which fuelled double-digit global inflation, and to combat that, central bankers were forced to hike interest rates. The resultant painful period of stagflation led to political reconfiguration in the United Kingdom and the United States.
A world already struggling with inflationary pressures due to supply chain disruptions caused by the Covid-19 pandemic has now been jolted by the Russia-Ukraine war. The conflict directly involves one of the leading energy exporters and two of the largest exporters of staple cereals as well as many other commodities. The spillover of this unrelenting acceleration of energy and food prices has hit Pakistan hard. With limited fiscal space to alleviate the burden on households and ensure food security, Pakistan’s economic challenges are being compounded.
According to the Food and Agriculture Organization of the United Nations (FAO), world food prices surged by 33.6 percent in March 2022 compared to a year earlier. Between February to March this year the FAO Food Price Index (FFPI) rose by 12.6 percent, which is the highest monthly spike observed since 1990. The latest increase reflects new all-time highs in vegetable oils, cereals and meat sub-indices. Unfortunately, this is likely to worsen as Indonesia, the world's top palm oil producer, banned exports of the most widely used vegetable oil on April 20th.
Prices of substitute edible oils such as soybean oil prices have also soared to a record high in reaction to Indonesia's ban on exports. The loss of shipments from Ukraine, the world's top supplier of sunflower oil, as well as reduced soybean oil supply from Argentina, had already depleted global supplies of alternative vegetable oils. Cooking oil is a significant component of household spending on food in Pakistan, and with its price rising, there is little likelihood of respite in food inflation anytime soon.
In the composition of Pakistan Bureau of Statistics (PBS)’s consumer price index (CPI), which measures changes in prices of average household expenditure items, food contributes almost a third of the weight. Putting it more simply, food is a major component of household spending and any significant rise in food inflation effectively implies a sharp reduction in the real disposable incomes of families. As the international food price rises are transmitted to Pakistan, these will cut into household spending, especially for those in the lower income brackets.
As international food price rises are transmitted to Pakistan, these will cut into household spending, especially for those in the lower income brackets.
Javed Hassan
According to PBS, year-on-year food inflation was 14.5 percent and 15.5 percent in March in urban and rural areas respectively, and is invariably likely to increase from here in the coming months. This will directly feed into the forward headline (CPI) inflation expectations that the State Bank of Pakistan (SBP) projects in order to determine monetary policy measures in order to rein-in galloping prices. The SBP is likely to be aggressive especially given that it is perceived so far to have been behind the curve in its inflation response.
SBP has had to revise its average inflation forecast upward to above 11 percent for the current fiscal year from its earlier forecast of between 9-11 percent as stated by the central bank’s Monetary Policy Committee on March 8, 2022. Moreover, the central bank’s “medium-term target range of 5-7 percent in FY23” appears to have assumed unrealistically benign conditions in global commodity prices for which there appears to be no evidence presently. Similarly, the International Monetary Fund (IMF) has been off target in projecting 11.2 percent average inflation for the current fiscal year, and expecting it to decline to 10.5 percent in 2023. With PBS national CPI rising by 12.7 percent in March year-on-year, and consistently remaining above 11 percent for preceding 5 months, both SBP and IMF projections for FY22 and FY23 require upward revision.
Headline inflation will almost certainly rise above the March level in the coming months. This would be the case even without including the inflationary impact of the Oil and Gas Regulatory Authority (OGRA) proposal to raise petroleum prices and power tariffs. IMF has indicated that these are necessary prior actions before the much-needed Extended Fund Facility (EFF) is revived. The domestic secondary debt market is indicating the likelihood of higher inflation and correspondingly tighter monetary policy by SBP. Six-month treasury bill rates jumped up close to 15 percent on April 27 from around 13 percent a week earlier.
World Bank and Asian Development Bank estimates of between 4.0 to 4.5 percent GDP growth for FY23 seem optimistic. Pakistan may enter a period of stagflation as high inflation and high interest rates persist for some time. Under such conditions, a youthful and restive population seeking employment opportunities could stress test the robustness of the polity.
— Javed Hassan is an investment banker who has worked in London, Hong Kong, and Karachi. He tweets as @javedhassan.
