KARACHI: Pakistan’s central bank has warned that any significant increase in energy prices may offset the impact of recent positive developments on the inflation outlook, urging the government to set an inflation target range in consultation with it.

The State Bank of Pakistan (SBP) said it had revised its inflation projection range to 23–25 percent for the current fiscal year against the target of 21 percent after the inflation hit all-time high of 38 percent in May last year, and had taken measures during the ongoing high inflationary episode to contain demand pressures and prevent de-anchoring of inflation expectations. 

The central bank cumulatively raised the policy rate by 1,500 basis points during FY22 and FY23 and maintained it at 22 percent as adjustments in energy prices, in the backdrop of longstanding structural issues, continued to impact inflation outturns. As a result of monetary tightening, supported by some fiscal consolidation, lower global commodity prices, and improved domestic crop output, the inflation came down from its peak of 38 percent to 29.7 percent in December 2023, whereas core inflation has also gradually started to decelerate. 

“Any significant increase in administered energy prices may offset the impact of positive developments on inflation outlook,” the central bank warned in its half-yearly report issued on Tuesday.

Higher input costs, increase in indirect taxes, and implementation of upward revision in minimum wage announced in the FY24 budget, alongside the second-round effects of administered prices of food and energy items, were responsible for the persistence in the core inflation during the first half of fiscal year 2023-24 (H1-FY24), according to the report.

“Despite subdued domestic demand and decline in global commodity prices, a combination of lingering structural issues, PKR (Pak Rupee) depreciation compared to H1-FY23, increase in government spending, and supply shocks kept the National CPI inflation at elevated levels,” it read.

The central bank also warned that its 23-25 percent inflation outlook may also be at risk due escalating geopolitical tensions, unfavorable weather conditions, adverse movements in global oil prices, and subsequent external account pressures, saying that it expected inflation to come down to 5–7 percent by September 2025.

To effectively anchor inflationary expectations, the central bank said: “It is important that the government sets the inflation target range in consultation with the SBP — ala the practice of joint agreements between the government and central bank in other countries, such as Canada, India and England.” 

It also necessitates that deviations from planned fiscal policies, including the setting of administrative prices, are neither significant in magnitude nor in timing to avoid affecting monetary policy credibility and stoking long term inflationary expectations, according to the report. 

It is imperative to relax the policy of price administration and to de-cap prices to help increase competition in the medium to long term and thereby lower inflationary pressure. While productivity growth is needed to improve supplies and lower per unit costs, there is also a need to significantly lower the pace of population growth to ease underlying demand pressures in the long term.

“There are gaps in collective and up to date understanding of inflation dynamics in the country,” the bank stated. “Plugging these gaps in understanding requires concerted efforts by academia, government institutions, and policy research institutes alike.”

Pakistan’s macroeconomic conditions somewhat improved during H1-FY24 and real economic activities moderately recovered against the contraction last year, while a $3 billion Stand-By Arrangement (SBA) with the International Monetary Fund (IMF) helped reduce stress on external account, according to the central bank. Continued tight monetary policy stance and fiscal consolidation are expected to keep domestic demand in check, with modest economic recovery expected in the second half of FY24.

In the backdrop of improvements in business confidence, high frequency demand indicators since November 2023 and prospects for a good wheat production during FY24, the SBP projected real GDP growth in the range of 2-3 percent for the current fiscal year.