ISLAMABAD, April 29: Inflation is expected to drop to about 8 per cent in 2006 from 9.3 per cent in 2005 owing to decline in aggregate demand and an anticipated improvement in food supplies, a UN report said.

The United Nations Economic and Social Commission for Asia and the Pacific’s flagship publication - Economic and Social Survey of Asia and the Pacific 2006 - linked the drop in inflation with the decline in aggregate demand implicit in the lower growth estimate, a high base effect for 2006 prices and an anticipated improvement in food supplies.

Many countries in the region including Pakistan were facing the problem of sustaining the higher growth momentum while maintaining macroeconomic stability. Containing inflationary pressures amidst rising oil prices has to be the main priority.

According to the report, judicious use of fiscal and monetary policies could help limit the increase in consumer prices. Several countries in the region are growing rapidly in part fuelled by higher consumer spending finance by credit.

The report suggested that there was a need to remain vigilant, especially where rapid economic growth was accompanied by a wider current account deficit and higher inflation.

Containing credit booms usually required strengthened surveillance of the banking system and close scrutiny of corporate borrowing during periods of rapid economic growth to prevent the impairment of asset quality in financial system, it suggested.

The current bout of high oil prices is hurting countries not only by threatening more sustained inflationary pressure but also by eroding the current account of the balance of payments.

If oil prices rise further by $10 a barrel, GDP growth of a developing country such as Pakistan could drop by 0.5 per cent, inflation could rise up to 1 per cent and current account deficit could widen up to 0.3 per cent of GDP, it said.

The report suggested that Pakistan should take steps to develop a long-term policy response to reduce oil dependency, improve energy efficiency and promote energy conservation.

Three years of strong economic growth, complemented by record low interest rates and the ongoing structural shift of many households towards higher consumption, have injected new life into domestic spending.

This spending coupled with the rising oil and other commodity prices contributed to a sharp increase in inflation in 2005. Food inflation reached double digit, a heavy burden on the poor who spend most of their income on food.