THE news that the regulator has asked for another massive increase in the price of gas, which might be as high as 221pc for some categories of consumers, has sent a shockwave through the business community. Those who rely on gas as a primary fuel, whether for boilers or captive power plants, could see their energy cost rise at a time when they are already struggling to keep their business running.

And perhaps more importantly, the price of gas could send yet another inflationary pulse through the economy, forcing the central bank to keep interest rates high at a time when the market is increasingly anticipating a cut in rates from around March onwards. Between high interest rates and high energy prices, the pace of economic activity and any sense of a return to economic growth could potentially be at stake, precisely at a time when the government has begun to talk about moving from stabilisation to growth.

A couple of things are important to point out though. First, the rise in inflation this year has been driven only partially from a rise in utility prices. In significant measure, it is also driven by devaluation of the currency, volatile oil prices at least in the first half of the year, and at least in part by higher taxes. At least that was the assessment of the State Bank back in July when it said that it expects inflation to average 11-12pc in FY20 from 7.3pc in FY19.

But that assessment was based, in part, on two hikes in utility prices, especially gas, one in July and the second in September. In the middle of September, in response to fiscal pressures, the government sought to raise an additional Rs94 billion from gas consumers through a raft of tariff hikes that were as large as 143pc for high-end consumers and as low as 10pc for those in the bottom slab. Additionally, industry was slapped with around 50pc increases in its gas tariffs. The new tariffs took effect at the start of October.

This time utility prices are responding to variables that the inflation forecast has most likely not included.

In the November monetary policy statement, the State Bank noted that inflation in October was “somewhat higher than expectations but largely reflected upward adjustments in administered prices and rise in prices of food items primarily due to temporary supply disruptions”. That month the Consumer Price Index rose by 1.8pc from the previous month, at a time when the expectation was that it would either be flat or perhaps start easing.

Each percentage point matters in inflation, because interest rates are pegged to it. The next month, in November, it climbed again by another 1.34pc, inching closer to the discount rate. The discount rate at present is 13.25pc, whereas the average inflation rate for the July to November period has risen to 10.8pc. Any further acceleration in the rate of increase could upset market expectations of an approaching rate cut.

Last year, inflation surged in part due to the price adjustments under way in the economy due to depreciation, but in large measure also due to large-scale government borrowing from the State Bank, a process akin to creating money which fuels inflation by degrading its value. This year, the government has kept money creation under check.

It got some help in this from the massive interest rate hikes that began in January 2018 when the discount rate was 5.75pc and continued unabated till July of this year by when it had gone to 13.25pc. This is quite possibly the single-most ferocious cycle of monetary tightening that our economy has ever had to absorb, in which interest rates have more than doubled in a year and half. But these hikes were required to reactivate the interest of banks in government debt, so direct borrowing from the State Bank could cease.

That is why by July there was a sigh of relief when the State Bank hinted that the cycle has now ended. “The [Monetary Policy Committee] is of the view that real interest rates implied by these inflation projections and today’s policy rate decision are at appropriate levels considering the cyclical weakening of aggregate demand.” Translation: that’s it for now folks!

Inflation has edged up since then but the band established by the central bank has not yet been entered into, let alone breached. The main drivers of the inflationary spiral — monetisation of the deficit, upward revisions in utility prices, rising oil prices, currency depreciation — are largely under control. The upward gas price revisions of July and September were factored into the forecast of annual inflation between 11-12pc. Aside from some disturbances in food prices, that have sent outsized impacts through the price level because of their high weightage, there has so far been no cause for alarm.

But now, the wild card of utility prices is threatening to make a comeback. Power tariffs may require an increase to help bring down the circular debt accumulation while gas tariffs may need to be increased to raise an additional Rs40bn for the two gas utilities (on top of the Rs94bn that the September hike sought to raise).

This time, utility prices are responding to variables that the inflation forecast has most likely not included. In the case of power tariff, for example, the government has made commitments under a $300 million loan from the Asian Development Bank to raise up to Rs469bn through quarterly adjustments in the power tariff in this fiscal year. They have also committed to announcing the next fiscal year power tariff by June 2020. Parking power-sector losses into the tariff is part of an ongoing ‘full cost recovery’ effort in the power sector, creating a source of uncertainty for the inflation outlook.

Unforeseen events in the price of power and gas could send a new inflationary pulse through the price level, potentially impacting interest rates and upsetting a lot of calculations in the private sector as well as debt-service schedules of the government. The time of uncertainty is not over yet.

The writer is a member of staff.

khurram.husain@gmail.com

Twitter: @khurramhusain

Published in Dawn, December 19th, 2019