Published On: Mon, Nov 4th, 2013

Inflation & interest rate outlook lifted post 9.1% Oct-13 CPI

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§        With 15.8% hike in electricity tariffs built into October 2013 CPI statistics and an uptick in food inflation, overall inflation for the month clocked in on the higher side, rising by +2.0% MoM and a sharpish +9.1% YoY.

We now expect November 2013 CPI to rise back into double-digits (10.1%). With inflationary pressure intact (wheat prices, 2nd round impact of electricity prices and imported inflation) and the low base of FY13, we lift our FY14E CPI inflation outlook to 10.1% (from 9.5% earlier).

With the above CPI outlook, we believe our earlier interest rate call (+100bp to 10.5% by June 2013) will prove too conservative. We raise our FY14E interest rate outlook, where we now pencil in a further 150bp monetary tightening (+200bp in FY14 overall) to 11.0% by June 2013.

-The next Monetary Policy Statement (MPS) is due sometime in mid-November 2013 and given the rising CPI trend, we believe SBP is likely to hike the Discount Rate by 50bp (to 10.0%).

-We take the opportunity to nudge up our FY14E Pak Rupee exchange rate outlook following sharper-than-eyed YTD FY14 currency weakness and anticipating a weak 2QFY14 on the external front. We lift our June 2013 PKR/USD exchange rate to Rs111.0/USD (from Rs107.5/USD earlier).

Oct-13 CPI rises 2.0% MoM; 9.1% YoY on electricity prices

With an average 15.8% hike in electricity tariffs built into October 2013 CPI statistics and an uptick in food inflation, overall inflation for the month clocked in on the higher side, rising by +2.0% MoM and a sharpish +9.1% YoY. While resultant 4MFY14 CPI inflation stands at a still-undemanding 8.3% YoY, we flag that with (1) the low base of FY13 (overall CPI for the year was just 7.4%); (2) expected ongoing strain of higher electricity prices in subsequent months and the likely second round impact of the same; (3) continued uptick in wheat and wheat product prices (+0.8-1.2% MoM in October 2013 where wheat and wheat products carry 4.6% weight in the overall CPI basket) and (4) expected imported inflation, post 8.1% YTD-FY14 Pak Rupee depreciation vs. the US Dollar, inflationary pressure should remain on the higher side this fiscal year.

FY14E CPI outlook now hiked into the double-digit zone

As flagged in our October 25, 2013 note ‘Electricity prices could play fast & loose with Oct 2013 inflation’ post incorporation of electricity tariff hikes, we expect November 2013 CPI to rise back into double-digits, where preliminary estimates suggest a 10.1% YoY CPI reading for the month. Note that this is expected to be Pakistan’s first double-digit CPI reading since the 11.3% inflation number reported in June 2012. On the back of the above, we lift our FY14E CPI inflation outlook to 10.1% (from 9.5% earlier) though flag that the same is still on the lower side vis-àvis State Bank of Pakistan’s (SBP’s) 11-12% FY14E inflation outlook. Key risks to our CPI outlook include (1) continued escalation in food inflation (+9.8% YoY in October 2013, +9.3% on average in 4MFY14); and (2) higher-than-expected hike in overall domestic gas prices in January 2014 (we plug in ~7.0% increase) in tandem with the government’s agreement with the IMF and the proposed December 2013 detailed gas price plan.

Resultant uptick in FY14E interest rate outlook

With overall inflation now expected to register at 10.1% in FY14E, we believe our earlier interest rate call (another 100bp hike in the Discount Rate (DR) over the remainder of FY14E to close the year at the 10.5% mark) will prove too conservative. While the IMF clearly flagged positive real interest rate as their goal for year two of the ongoing Extended Fund Facility (EFF) program, we believe that given higher inflationary expectations, the same is going to remain the unstated goal for FY14E as well where in the past 10-years, Pakistan’s real interest rate has averaged +1.5%. In line with the uptick in our inflation expectation for FY14E, we also increase our interest rate outlook where we now pencil in a further 150bp monetary tightening in FY14E (+200bp for the full-year) with a June 2013 DR outlook of 11.0%. With the next Monetary Policy Statement (MPS) due sometime in mid-November 2013 and a rising CPI trend, we believe the SBP is likely to hike the Discount Rate by 50bp (to 10.0%) in the upcoming MPS.

FY14 Pak Rupee exchange rate also nudged up

Meanwhile, though unrelated to October 2013 inflation, we also take the opportunity to nudge up our FY14E Pak Rupee exchange rate outlook following sharper-than-eyed YTD FY14 currency weakness and anticipating a weak 2QFY14E (Sep-Dec 2013) on the external front where (1) repayments to the IMF are anticipated at US$1,030mn vis-à-vis expected disbursement of US$550mn and (2) media reports suggest that IMF’s review may result in SBP buying ~US$100mn from the open market to shore up its foreign exchange reserves. Note that the Pak Rupee has already slid by 8.1% YTD FY14 and while October 2013 should be a relatively good month on the external front (US$322mn of Coalition Support Fund inflow booked), November 2013 is expected to be a rough patch with IMF SBA repayment alone standing at US$720mn. Factoring in the same, we lift our June 2013 PKR/USD exchange rate to Rs111.0/USD (from Rs107.5/USD earlier).

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