Elixir Securities Limited – Elixir Insight


Karachi, November 23, 2017 (PPI-OT): Pakistan Economy – Inflation and Monetary Policy Preview

SBP is slated to announce its Monetary Policy decision on 24th November, where we expect it to keep Policy Rate / Discount Rate unchanged at 5.75% / 6.25%.

CPI inflation is expected to rise to 4.0%YoY in Nov-17 from 3.8%YoY in Oct-17, mainly due to relatively higher base effect compared to that in preceding month. Nonetheless, the inflation is expected to remain soft in upcoming months with moderate risk emanating from PKR depreciation, higher energy prices and higher government borrowings.

As such, we anticipate interest rate liftoff to begin from May-18, while maintaining our expectation of 3 hikes of 25bps each in 2018.

Status Quo Expected on Tepid Inflation Projections: State Bank of Pakistan (SBP) is slated to announce its Monetary Policy decision on 24th November, where we expect it to keep policy rate/discount rate unchanged at 5.75%/6.25%. The decision is expected to be based on softer inflation (attributable to adequate supply of major food items, lower domestic oil prices, and stable exchange rate) as the Monetary Policy Committee (MPC) in its latest minutes stated that it expects average headline inflation to stand at 4.6% (same as our projected estimate) in FY18. Further, the Committee expects CPI to remain between 4.5%-5.5% even if higher energy prices, higher government borrowing, and exchange rate depreciation are incorporated in projections.

MPC recorded a vote of 8-1 in favour of Status Quo against 15bps cut in interest rate in Sep-17 Monetary Policy Meeting. The stance to maintain status quo was based on maintaining stability and support economic growth and concerns over weakness in external account, whereas the vote dissent was based on available room to cut interest rate to attain stronger growth with below-target inflation. Since the situation has not changed much, we expect similar decision in Nov-17 Monetary Policy.

MPC believes that FY18 GDP growth target of 6.0%YoY is expected to be led by growth in industrial and services output. Besides, the agriculture sector is expected to continue its healthy growth trend and may exceed the target of 3.5%YoY in FY18 owing to increase in area under cultivation to 6.9mn hector in FY18 from 6.4mn hector and increase in fertilizer usage. Large Scale Manufacturing (LSM) is also expected to maintain its growth trend. The GDP growth target seems realistic and achievable based on the trend of real economic activities. Though MPC expects demand for Pakistan’s exports to grow based on rising global growth, it remained cautious of weakness in external account. As such, we believe that MPC’s tone indicates their view of continuing status quo in upcoming months (or even till the end of FY18).

Greater Participation in T-Bills and Unsuccessful PIBs Auctions: T-bills yields have remained stable indicating expectations of no change in interest rates in upcoming months. Besides, greater participation (88%/12% in 3/6-month T-bills) was seen in shorter maturities during the recent auction. PIBs yield curve has steepened and unsuccessful PIBs auctions in recent months due to lackluster response of participating banks indicate that the market is building up expectation of rising interest rates in later months.

Inflation Expected at 4.0%YoY in Nov-17: The weekly Sensitive Price Indicator (SPI) data indicates that Nov-17 CPI inflation is likely to stand at 4.0%YoY vs. 3.8%YoY in Oct-17. Expected uptick of 0.2ppt in CPI YoY inflation (between Nov-17 and Oct-17) is likely to be a result of increase in energy prices and food item prices. Nov-17 CPI inflation is expected to rise by 0.4%MoM however, the high base effect (-0.2ppt) of last year is expected to keep YoY inflation subdued.

Among the individual CPI components, transport/furnishing/food inflation are expected to register relatively greater increases as they are projected to go up by 1.3%MoM/0.4%MoM/0.3%MoM. Higher food inflation is likely to be attributable to 0.8%MoM/3.1%MoM increase in fresh fruit/wheat flour prices (weight in CPI basket: 1.9%/4.2%).

Non-Food Non Energy (NFNE)/ Relatively Stable Component (RSC)/ 12-month moving average inflation are expected to remain flat at 5.3%YoY/4.3%YoY/4.0% in Nov-17 due to low base effect (-0.2ppt) of last year for both NFNE and RSC inflation.

FY18E Inflation to Remain Subdued: We expect CPI inflation to continue to inch up as base effect ebbs out. Going forward, CPI inflation should reach 5.0%/6.0%YoY in Dec-17/Jun-18. However, adequate supply of major food items, lower domestic oil prices, and stable exchange rate are likely to keep average FY18 CPI inflation at 4.6% vs. 4.2% in FY17.

NFNE and RSC inflation are both expected to depict rising trend though less pronounced closing at 4.5%/5.8%YoY and 5.5%/6.4%YoY in Dec-17/Jun-18, respectively. Higher oil prices are expected to remain sticky at least in upcoming months due to Middle East tensions. However, it may have a relatively dampened effect on inflation as the government can manage local POL products’ prices by adjusting already high sales taxes. Nonetheless, there is no significant risk to inflationary pressures as further oil price increases are unlikely.

Anticipation of PKR depreciation owing to overvaluation and deteriorating external account balance are other risks to inflation as imports account for ~20% of GDP. In this regard, we estimate that every 1% depreciation of PKR (over and above our base case) would raise MoM inflation by an additional 0.8ppt.