KARACHI, Jan 12: Inflation measured by the Consumer Price Index shot up to 3.08 per cent year-on-year in the first half of this fiscal year against the full year target of 3.9 per cent. Economists link this to an unprecedented rise in currency in circulation (CiC).

Data released by the Federal Bureau of Statistics show that CPI inflation rose 3.08 per cent in July-December 2003. The economic managers have set the target of CPI inflation at 3.9 per cent for the full fiscal year of 2003-04. The State Bank in its first quarterly report said indications were that it could settle around 3.6-4.2 per cent. But economists say there are more chances for inflation to settle closer to 4.2 per cent or even higher.

"We should not forget that currency in circulation had risen phenomenally during the first half of this fiscal year," says economist Dr Javed Akbar Ansari. "This was bound to push inflation up."

The currency in circulation rose by Rs82.8 billion or 16.8 per cent between July 1 and December 27, 2003, according to a weekly data released by the SBP. More importantly this increase in currency in circulation made up about half the total monetary expansion - or increase in broad money (M2). Economists say and central bankers admit that a higher percentage of CiC in M2 is considered highly inflationary.

And rise in currency in circulation means people are holding more cash. "Apart from creating inflationary pressures increased currency in circulation always undermines the government's efforts to document the economy," Dr Ansari told Dawn.

He said that a big increase in CiC also showed that workers' remittances or the money sent back home by overseas Pakistanis were being used more for speculation rather than for real investment. In five months to November 2003, workers' remittances totalled $1.488 billion that should have reached a little less than $1.8 billion by end-December, generating rupee funds of more than Rs100 billion. Exact figures for end-December remittances would be out shortly.

The central bankers say they have been making efforts to contain the rise in currency in circulation and that these efforts have yielded results. CiC had expanded by about Rs98 billion in October-November last year, "but we managed to reduce it to Rs82.8 billion in December," said a central banker. He said CiC had risen primarily because of higher consumption during this Eid, adding that part of the money withdrawn from banks during Ramazan for Eid shopping returned to the banking system in December. The official said CiC increased in Ramazan every year because many people who are not aware of the relevant rules withdraw money to avoid deduction of Zakat. "That money too finds it way back into the banking system."

But historical data compiled by the SBP show that the rise in currency in circulation during September-October last year was the largest not only in volume, but also as percentage of M2 in past several years.

This means there were some specific reasons for a big rise in CiC in the last quarter of 2003. People say and central bankers generally agree that frequent cuts in the rates of return on bank deposits and on national saving schemes have also forced people to hold cash - or invest in least documented sectors of economy.

Small wonder than people are out to invest in hard currencies like euro and sterling - also in Iraqi dinar. Money changers' business is considered one of the least documented one - and top currency speculators also make illegal transfer of funds abroad.

The increase in inflation in the first half of this fiscal year may force the central bank to slightly tighten its monetary policy in the next half - between January-June 2004. If that happens it would allow the interest rates to move up further. The average lending rate of banks has already started inching up on expectations of rising inflation and a change in monetary policy stance.

The FBS data show that whereas CPI inflation was up by 3.08 per cent year-on-year in July-December 2003, it was up by 5.41 per cent in December 2003, over December 2002. And monthly inflation in December 2003 over November 2003 was 0.9 per cent - too high to keep yearly inflation from rising past four per cent.

Given this structure it seems too difficult for the monetary authorities now to keep CPI inflation from bursting even the upwardly revised projection of 4.2 per cent. The market is waiting for SBP monetary policy statement for January-June 2004 to have a clearer perception. The central bankers say the statement is due early next week.