Karachi, August 02, 2023 (PPI-OT): Elevated July CPI could reignite monetary policy discussion

Inflation for Jul-2023 clocked in at 28.3%, higher than street estimates of ~26%. Dissecting the datapoint, the higher than estimates reading was driven by variation in two heads, carrying substantial weights in the CPI basket - food and electricity.

With food inflation at 4% MoM and electricity price increase at 40% MoM, the month's sequential increase clocked in at 3.45%, continuing a relatively higher MoM pace trend. For perspective, the country's recent average for MoM inflation clocks in at 2% (past 2 years), where average for the period prior to recent macro adjustments clocks in at 85bp.

The inflation reading for July is likely to open up discussions on monetary policy - given the fine margin between positive and negative real interest rates. The current Policy Rate of 22% is backed by SBP forecasted CPI range of 20-22% for FY24. Following July's elevated reading, this would require MoM inflation to average at 1% MoM for remainder of the fiscal year.

Near term pressure from POL price increase and its second-round impact will likely exert upward pressure on market expectation on inflation and hence interest rates. In terms of sensitivity, keeping timing differences aside, if we maintain our average MoM trajectory of 1.2% MoM, CPI for FY24 would average 23% vs our earlier base case of 21%.

Jul-2023 CPI at 3.45% MoM on 40%+ MoM power costs

Inflation for Jul-2023 clocked in at 28.3%, higher than street estimates of ~26%. Dissecting the datapoint, the reading came higher than our estimates on account of variation in two heads, carrying substantial weights in the CPI basket – food and electricity. The month’s food inflation clocked in at 4% MoM (JS estimates 2% MoM), which carries 30% weight in the basket. On electricity, where the recent increase in power tariff was expected to translate into an increase of 25%; the reading discloses a 40% MoM increase.

As a result, month’s sequential increase clocked in at 3.45%, continuing a relatively higher MoM pace trend. For perspective, the country’s recent average for MoM inflation clocks in at 2% (past 2 years), where average for the period prior to recent macro adjustments clocks in at 85bp. On the other hand, core inflation clocked in at 22.9% (+3.5% MoM) while WPI came at 23.1% (+2.5% MoM).

Higher base and sharp POL price hike revises CPI estimates

With a high base set for July-2023, inflationary trajectory, assuming sequential increases for the remainder of the year, takes a step up of 200bp for average of FY24, adding 30bp from the sharp POL product price increase to be reflected in Aug-2023. Estimating average increase of 120bp MoM (keeping timing differences aside) during Aug-2024 to Jun-2024 takes FY24 average CPI to 23% (from current base case of 21%). These estimates include 40% gas price hike and higher food inflation in 1QFY24 as a result of second round impact from aforementioned factors.

Quantum of PKR deval – a key risk

Given Pakistan is a net importer of essential consumption items such as petroleum, edible oil and other food products, a key risk to our projections emerges from sharp PKR devaluation against US$, as these products carry material weight in the CPI basket. Where substantial support to SBP foreign exchange reserves in the past one month led to gains of ~5% within 3 working days, the same eroded in the following 3 weeks.

As per recent brief by SBP Governor, Pakistan’s external needs this year suffice through roll over expectations, where almost half of the US$21bn scheduled debt obligations are anticipated to be rolled over. While almost US$5bn of these have already been secured, delay in commitments from the remaining US$6bn would potentially create pressure on PKR/US$.

Moreover, given the outsized importance IMF has given to open market rates, there will likely be enhanced volatility - every now and then. While the government is expected to look for continued moderate depreciation, the 1.25% gap restriction between interbank and open market rates by IMF may keep volatility on both ends.