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JS Securities Limited – JS Research (January 30, 2023)

Karachi, January 30, 2023 (PPI-OT): Impact of back-to-back macro developments on CPI

A sharp Rupee devaluation of 12% in last two trading sessions of last week, followed by POL product hike announcement of Rs35/litre over the weekend, have raised concerns over impact of the same on CPI. In our note today, we dissect the CPI basket and analyze impact of PKR movement on inflation in various scenarios.

Under first scenario, assuming bulk of immediate PKR adjustment against US$ has materialized and expected hike in energy costs also follows soon, we expect sharp spike in MoM CPI in next 2 months, followed by softer MoM readings in subsequent months. This should result in FY23 average CPI inching marginally higher to 27% from 26%.

In case further devaluation materializes soon and / or energy price hikes are higher than our expectation of 40% gas and 20% electricity price hikes, then we would see upside risk to our CPI estimates.

In any scenario, given the bulk adjustment in currency, a 30% YoY CPI reading now seems inevitable. This is broadly led by direct impact on ~20% of the CPI basket accumulated by fuel, edible oil and items for which Pakistan is a net importer.

PKR declines by 12% in two days

A sharp rupee devaluation of 12% in the last two trading sessions have evoked mixed feelings among the market participants. On one hand, the country moving towards market-driven exchange rate is another step closer to progressing towards the ninth IMF review – critical for unlocking FX inflows at a time when import cover is down to a couple of weeks. On the other hand, it raises concerns over impact of the immediate fall in rupee impacting inflation. The concerns stand exacerbated by the POL product hike announcement of Rs35/litre. In our note today, we dissect CPI basket and analyse impact of PKR movement on inflation in various scenarios.

In our current base case, we have already incorporated 40% gas price increase, 20% power tariff increase and resumption of GST on POL products in Feb-2022. Hence, this includes the Rs35/litre POL product hike announced yesterday, and another ~Rs40/litre for GST application. Beyond the measures, we take a higher MoM inflation increase of ~80bp, when compared to historical average of ~70bp and present scenario analysis of various MoM paces.

30%+ CPI readings seem inevitable

First, assuming most PKR adjustment against US$ has materialized, we expect a higher MoM CPI for the coming months, followed by softer MoM readings in subsequent months. The same would also then increase the base for 3QFY24’s CPI, reducing CPI pace for FY24. This would mean higher CPI levels from current base case in immediate months, and reversion to earlier forecasts beyond that.

The second scenario would be further PKR devaluation from here. In this scenario, CPI levels may witness a parallel upward shift from current base case estimates.

In any scenario, 30%+ CPI months now seem inevitable. This would further create pressure on monetary stance, which has been on a tightening mode for over a year to anchor inflation. Moreover, as IMF stresses upon importance of tightening policy to reduce inflation and for central bank to be proactive as the situation unfolds, the prospective 1300bp+ negative real interest rates will require regulators attention.

Impact broadly from energy and food

Pakistan being a net importer of energy, inflation basket’s major component that is impacted by PKR movement is Motor Fuel (~3% weight of CPI basket), a sub category of Transport segment (~6% weight of CPI basket). Other energy components in the CPI basket are gas (~1% weight of CPI basket) and electricity (~4.5% weight of CPI basket) charges. However, gas and electricity have partial contribution of indigenous-sourced supply. Moreover, cooking oil and allied products (~2% weight of CPI basket) and readymade food (~5.5% weight of CPI basket) also have a direct impact of PKR movement as Pakistan is a net importer of edible oil as well. The 12% PKR depreciation on the accumulative ~20% of the basket alone marks for 240bp MoM higher inflation in the coming month (or as its respective imports realise).

Higher transport costs would trickle down too many segments. A higher correlation has especially been witnessed in the food and beverages (~31% of CPI basket), Clothing (~8% of CPI basket), Household equipment (~4% of CPI basket) and Miscellaneous (~5% of CPI basket) segments. The heavy-weight sub-segment under Miscellaneous is Appliances. Assuming adjustments in prices of the said segments brings another ~550bp increase, that may spread over two months.

Commodity price swing

Any relief from softening global oil prices would be an upside to the above presented scenarios. As we have witnessed 30% decline in ex-refinery prices since Jun-2022 assisting the government keep retail POL product prices sticky, simultaneously imposing PDL to increase revenue collection; further international oil price decline would provide some respite to CPI.