Analysis: Interpreting the ‘illusory’ inflation index

ECONOMIC jargon can occasionally confuse people, and, as in most other countries, politicians in Pakistan are also given to simplifying difficult statistics — often out of context — to paint a misleading picture.

For many of us, a similar situation occurred following the release of the average monthly inflation rate for September, which showed a 44-month low.

From the upper echelons of incumbent government to party workers, everyone seems to be jubilant that inflation has been reined in, resulting in lower prices.

The average monthly inflation rate in September was 6.9 per cent, the lowest since January 2021 (5.7pc).

There are quite a few things that could be improved about the CPI methodology, which currently doesn’t actually capture the cost of living in real terms

According to the Pakistan Bureau of Statistics, the average accumulative inflation rate over the last 44 months increased by 83.13pc, reflected in the retail prices of all consumer items, particularly the 17 items mentioned in the table.

Parties in the ruling coalition capitalised on the decrease in the inflation rate to build a narrative that the cost of living had come down significantly, thanks to their policies. However, there is much to unpack in this claim before we can truly celebrate.

The average inflation rate for six months (Jan-June FY21) was 9.2pc, followed by 12.5pc rate in FY22, 29.18pc in FY23, 23.41pc in FY24, and 9.19pc in the first three months of FY25. The data shows a rise in prices since January 2021, contradicting the government’s assertions that prices have declined.

Pakistan, like other countries, measures average inflation using the Consumer Price Index (CPI).

The current scenario is one of disinflation, which indicates a decrease in the pace of the inflation rate, whereas deflation (the opposite of inflation) occurs when general price levels fall.

Lost in translation

Former finance minister Miftah Ismail says that politicians tend to cause confusion when translating inflation rates. He said the rate at which prices rise has slowed, but this does not imply that the price level has decreased. Mr Ismail further notes that the low rate of inflation in September was primarily attributable to a strong base effect from last year, and declining international commodity prices.

The former minister questions the government’s role in reducing inflation, as it has not lowered its own expenditures. Oil prices fell in the international market, as did LNG, wheat, urea, and DP fertiliser prices. Furthermore, the highest-ever interest rate has reduced demand. Mr Ismail is concerned that any rise in international oil prices will cause inflation to rise to 11-12pc in the next three months. The government, he maintains, has taken no tangible measures to slow the inflation rate and maintained that its tall claims were baseless.

In contrast, a few products may have witnessed a fall in September 2024 compared to the previous year. Wheat and its products, cooking oil, sugar, petrol, diesel, and electricity, all had lower retail prices than the previous year.

Technical trickery

Dr Abid Suleri, executive director of the Sustainable Development Policy Institute (SDPI), explains that technically, the government’s claim of lower inflation is correct.

However, the figure that is yielded by the methodology used to calculate inflation does not automatically imply that prices have fallen; all it shows is that prices have risen or fallen by a certain percentage, as compared to the previous year (year-on-year comparison) or previous month (month-on-month comparison).

In this scenario, September 2024 represents a 6.9pc rise above September 2023 prices.

Former economic adviser Dr Ashfaque H. Khan explains the difference between prices of commodities and inflation. A decline in inflation does not mean that prices of commodities are falling, it only represents the speed at which prices of commodities is rising, he says.

The rupee exchange rate, which experienced wild fluctuations in previous years, has become relatively stable in recent months. Oil prices are also on a downward trend in the global market. In addition, bumper crops have kept the price of wheat quite steady.

When these factors are combined with a high interest rate, which according to Dr Khan also drives up the borrowing cost and, resultantly, drives up the cost of capital, it makes it seem like inflation has slowed.

Electricity conundrum

There are quite a few things that could be improved in the CPI calculation methodology, with household consumption of electricity and natural gas being one of the glaring examples.

The CPI index only considers changes in power bills for those using up to 50 units, Since this meagre consumption falls in the ‘lifeline’, which has been guarded by successive governments against any major changes in tariffs, it does not accurately reflect the way power costs affect the average consumer.

For context, the tariff for this category of consumers is Rs6.48 per unit, which has remained stable for several years.

The per-unit base price for power consumption between 51 and 100 units is 7.7pc, while the rate increased to 39.15pc for the 301-400 unit slab, 42.78pc for the 500-600 unit slab, and 48.84pc for those using more than 700 units.

To be clear, these tariff prices do not include taxes, fuel adjustments and other overheads, which have driven up power costs substantially in recent months.

Rising production costs

These are not the only factors to be when calculating the cost of living.

According to Dr Ashfaque H. Khan, there are four factors of production: labour, capital, raw material and energy.

Over the past two and half years, energy prices (electricity and gas) have risen quite often. The cost of imported raw materials is also rising as a result of devaluation. The high interest rate adds to the cost of borrowing, which fuels a rise in production costs, which is passed on to consumers.

The decline in purchasing power prompts calls for an increase in minimum wages and salaries of the both private and government-sector employees, which only adds to the cost of production. Higher inflation erodes the purchasing power of the people, putting them under tremendous pressures, he says.

Published in Dawn, October 13th, 2024