Karachi, September 18, 2023 (PPI-OT): Oil price shock - An addition to ongoing challenges

After some ray of hope from global oil prices in 1HCY23, the commodity price has spiked 27% (US$20/bbl) in three months, reaching a 10-month high as it crosses US$95/bbl. The commodity is a key contributor to the country's trade balance and inflation, two data points that carry much importance in the current economic landscape.

Rise in prices of imports that now contribute ~30% to the import bill is likely to expand our trade deficit. An assumption of every US$5/bbl increase in average oil prices for the remaining year would increase our CAD estimates by ~US$750mn (~0.22% of GDP) - 10% of our existing SBP FX reserves. Expanding CAD in the present situation where Pakistan's central bank's FX reserves hold an import cover of less than 2 months is worrisome.

Running similar sensitivities on CPI, every US$5/bbl (+5%) oil would likely add 30bp to headline inflation. Second-round impact would also follow in food and related segments that carry ~40% weight in CPI basket. As SBP believes current Policy Rate levels reflect a positive real interest rate based on forward looking inflation readings, any upward revision in expected forward CPI could warrant a revisit of the status quo monetary policy stance assumed over the last two MPC meetings.

Oil prices reach 10-month high

After some ray of hope from global oil prices in 1HCY23, the commodity price has spiked 27% (US$20/bbl) in three months, reaching a 10-month high, and closer to average oil price during CY22, which was around US$100/bbl. The gain has been led by change in expectations of tight supply market, overweighing previous lower demand concerns. As per the International Energy Agency (IEA), the recent voluntary extension of output cuts by Saudi Arabia and Russia are expected to outweigh the global demand of 101.8mn bbl/d, leading to massive market deficit in 4QFY23. The record-high supply of 50.5mn bbl/d by Non-OPEC+ members has not been sufficient to counter the output fall from OPEC+

Pakistan - the net oil importer

Pakistan being a net oil importer is on the unfavourable end of ongoing oil price rally. The commodity is a key contributor to the country’s two data points that carry much importance in the current economic landscape:

1. Trade balance (given high trade deficit where 30% of imports fall under Petroleum segment) and

2. Inflation, with direct impact on the 6%-weight segment - transport and followed by second round impact on ~40% of the basket;

We share historical key macro data points alongside oil price movement. We understand there are many moving parts in the various time periods, where the graphs are only for some perspective.

30% share of the import pie is set to rise

While CAD has been relatively controlled with trade deficit down ~40% YoY, the decline is largely contributed to prioritizing essential imports, trading off the country’s productivity. Rise in prices of imports that now contribute ~30% to the import bill is likely to expand our trade deficit.

The trade data of Jul-2023 reflects realized crude oil prices at US$90/bbl, which is par to our base case. This means any increase from here is a downside to our FY24E Current Account Deficit of US$5.8bn (1.7% of GDP). An assumption of every US$5/bbl increase in average oil prices for the remaining year would increase our CAD estimates by ~US$750mn (~0.22% of GDP) – 10% of our existing SBP FX reserves of US$7.6bn.

Expanding CAD in the present situation where Pakistan’s central bank’s FX reserves hold an import cover of less than 2 months is worrisome. To recall, the country is already burdened with tall US$19bn debt obligations for the remainder of FY24, that are dependent on rollover commitments of US$8bn and new lending of US$14bn.

On the other hand, this may lead to further tightening of imports to counter the potential rise in import bill, resulting in further sluggish economic activity. To recall, LSM has reported a negative growth of 10%, where delay in imports is among the key factors.

Extending more pressure on forward inflation data

The ongoing CPI trend, reaching multi-decade high, has been Pakistan’s recent Achilles heel. Recent oil price increase has begun to contribute to CPI, where second-round effects have yet to be seen in numbers. POL product prices have been increased 30% in the last 2 months on account of the rising oil prices. These price increases have incorporated PKR/US$ level of 302, baring lesser room for any savings from the recent PKR appreciation.

While we expect FY24F average CPI to clock in at 23% (including price increase over the weekend), rising oil prices are likely to revise our estimates. Transportation segment alone is 6% of the CPI basket. Running similar sensitivities, every US$5/bbl (+5%) oil would likely add 30bp to our headline inflation. Given the historical strong correlation of inflation with oil price trend, albeit with a lag, gives a higher probability of second-round impact of higher oil prices to also kick in to food and related segments that carry ~40 weigh to the basket. We highlight, the correlation has recently witnessed a disconnect over impact of sharp PKR depreciation and higher food inflation on CPI.

As SBP believes current Policy Rate levels reflect a positive real interest rate picture based on forward looking inflation readings, any upwards revision in estimate in forward CPI could resume monetary tightening, in addition to delay in prospects of monetary easing, which is currently expected from 4QFY24. We present sensitivities of MoM inflation pace.