By: Saad Khan, Arif Habib Ltd.
The relatively favorable inflation figure (headline 10.1%YoY, Jan-12) and stable external account (current account balance USD +160mn, Dec-11), have left stakeholders hoping for a rate cut in the upcoming Monetary Policy Statement (MPS) on 11th Feb-12. Although at current levels CPI inflation remains well accommodative to absorb further cuts in discount rate (real rates adjusted for headline inflation ~2% as of Jan-11), we believe that policymakers will not be too tempted to cut the rate given the deteriorating major economic indicators.
Policy cut to induce inflationary risks
In our view, any decision by policy makers to slash the discount rate if any would be a self invitation to inflation risk, which in the current time is clearly tilted towards the upside. Firstly any decision of policy rate cut will likely bring inflation risks to the forefront. Secondly, by further weakening of exchange rate when combined with high oil prices posts a risk of broader contamination to headline CPI inflation.
Although inflation has taken a respite during the 1HFY12…
Although the easing inflationary pressures in 1HFY12 allowed SBP to cut discount rate (ex. Nov-11) by 200bps, we think this situation is less likely to prevail in 2HFY12. We base this due to the fact that the factors which were primarily responsible for weak prices (base effect and stable commodity prices) have either subsided or carry with them potential upside risk. Inflation respite in first half won’t be visible in second half.
On a monthly basis it still remain a different story
On a monthly basis the headline inflation is showing no signs of slowing down. During 7MFY12 the MoM inflation has registered on average ~1.2% growth (ex-December) compared to ~1.6% in the corresponding period last year. Remember that this was a key concern in the last MPS issued in Nov-11. This rigidness in core prices, which remain downward sticky (NFNE still at 10.2% YoY and Trimmed, 10.4% YoY for the period of Jan-11) hints towards materializing of second round effects of high oil prices (4QFY11, Gulf Arab Light averaging USD ~113/bbl, against USD ~108/bbl 1QFY12, ~+109% YoY). As core prices continue an upward trajectory chances of this price pressure feeding into headline inflation can not be ruled out yet. Although we understand these risks in inflation are more structural based to which monetary policy can do little to counter in the short run. But we think given the cyclical nature of foreseeable inflationary risks, the policy makers can entail a policy which in the least manner can subdue these risks, that is by keeping the currency value steady.
Exchange rate and inflation pass through
The pass through affect on policy change on exchange rate may not be well pronounced but movements in exchange rate directly lead towards changes in the domestic price. To what extent exchange rate affects domestic inflation depends on many factors – country’s degree trade liberalization, sensitivity to external shock etc – but in the current context we believe primary factor affecting the exchange rate (and thus domestic inflation) is the lack of foreign capital inflows. A sharp run down in Net Foreign Assets (NFA) reflects worsening of BoP position and a pressure on exchange rate. The NFA stock (as of 27th Jan-12) has declined by almost 21%, which was concurrently led by a sharp PKR depreciation of ~5% FY12TD.
This mix of exchange rate movements and the relative uncertainty of inflation, in our view, can cause serious anxiety for policy makers. In our view the inflationary risks are certainly tilted towards the upside, owing primarily to rising oil prices. Therefore, any sharp move in exchange rate through discount rate will eventually amplify the problem of inflation. Hence the key question for the policy makers in our view would be whether to allow inflationary risks to further protrude in terms of further depreciation of PKR. We think this time monetary policy decision committee is likely to keep the rates at a hold.
Monetary Policy Preview
By: Syed Saquib Ali, Gloabal Securities Pakistan Ltd.
SBP is scheduled to announce its monetary policy for the next two months on Feb 11’12 and we expect the central bank to keep the discount rate unchanged at 12%. Our premise is based on the deteriorating outlook on the external front coupled with high levels of government borrowing. On the other hand, we believe inflationary expectations offer SBP the room to enact a cut of 50bps where undue interference from the federal government cannot be ruled out. However, we believe the central bank’s focus on the government meeting quarter end borrowing limits – and its subsequent breach in Dec11 – will sway the central bank’s decision towards maintaining status quo.
Inflation –built up in pressures likely
CPI inflation for Jan12 clocked in at 10.10% YoY against 9.75% in Dec11 and 13.91% in Jan11. Monthly inflation for Jan12 works out to 1.54% against a deflation of 0.70% in Dec11 where several factors featured into the rise during the month under review. The imposition of development surcharge and an increase in tariff for gas consumers along with quarterly survey for house rents translated into an uptick of 2.27% MoM in inflation for heavy weight ‘Housing, water, fuel & lighting’ against 0.09% in Dec11. Moreover, higher CNG prices also affected inflation for the Transport segment which stood at 1.34% MoM during Jan12 against 0.62% in Dec11.
Moving forward, an increase in fuel prices by 3-6% during Feb12 is likely to add to inflationary pressures where the secondary round impact, particularly on food prices is of particular concern. Persistent exchange rate devaluation is another red flag with the PKR touching new lows against the USD during the last two trading days, having shed 0.76% since Dec11. CPI inflation during 7mo FY12 has averaged at 10.78% YoY while we expect the same to average at 12.89% during the period Feb-Jun12, bringing FY12E average to 11.66%.
Quasi financing of the fiscal deficit
The government continues to finance its fiscal operations through borrowing from the central bank and scheduled banks, crowding out the private sector. Outstanding stock of budgetary borrowing has risen sharply by 31.3% during FY12TD against a meager growth of 6.7% in credit to the private sector. More importantly, the central bank has continually emphasized on the government’s commitment to meet the quarter end limit of PKR 1.15tr for cash borrowing from SBP. The same stood at PKR 1.31bn as of Dec 30’11, breaching the mutually agreed limit by PKR 151bn while the government had borrowed an additional PKR 32bn by Jan 20’12.
Moreover, the outlook on the external front continues to remain bleak with high oil prices and curtailed production of the textile sector key risks to the current account. Similarly, the first repayment of USD 400mn to the IMF is due in Feb12 where the overall external account scenario leads to two key implications for the economy – 1) Additional pressure on the PKR and its resulting impact on inflation; and 2) Financing of the twin deficits through additional borrowing with limited external sources.