-With a sharp WoW spike witnessed in the latest Sensitive Price Index (SPI) inflation numbers (+2.64% WoW on the back of an estimated 19.5% hike in average domestic electricity tariffs), we return to the drawing board on our expected October 2013 CPI inflation number.
-As against our earlier CPI outlook for the month at 8.13% (base-case); we flag that in the likely scenario that the SPI spike translates into CPI numbers via higher power tariff, we could be looking down the barrel at worse-case scenario of 9.10% CPI inflation in October 2013. This would translate into FY14E CPI of 10.3% vis-à-vis our 9.5% base-case estimate.
-Recent ~40bp decline in 10-year PIB yields suggests lower conviction on the anticipated November rate-hike. We meanwhile flag the risk of sharper than eyed Discount Rate hikes if CPI numbers revert to double-digit sooner than expected and turns real interest rate negative. Recall over 2000-2013, Pakistan’s real interest rate has averaged at +1.5%.
Risk to Oct 2013 CPI as electricity costs push up SPI
With October 2013 drawing to a close and a sharp sequential spike witnessed in the latest weekly Sensitive Price Index (SPI) inflation numbers (+2.64% WoW on the back of an estimated 19.5% hike in average domestic electricity tariff) published by Pakistan Bureau of Statistics (PBS), we return to the drawing board on our expected October 2013 CPI inflation number. As against our earlier CPI outlook for the month at +8.13% YoY and +1.08% MoM (base-case); we flag that in the likely case that the SPI spike translates into CPI numbers, we could be looking down the barrel at worse-case scenario of +9.10% YoY (+1.98% MoM) CPI inflation in October 2013. The caveat here is timing, where the CPI methodology published by PBS suggests that data for electricity prices is collected over the first three day of the month whereas the SPI spike has occurred in the week ended October 14, 2013. That said, if the electricity tariff hike is going to show up in CPI numbers (a likely scenario in our view), then the timing will largely be a technicality as November 2013 and onwards inflation reading will spike up. Note that incorporating an average 19.5% increase in electricity prices October 2013 onwards raises our base-case 9.5% FY14E inflation estimate to 10.3%.
Double-digit inflation could strike as early as Nov 2013
Recall, our base-case inflation and interest rate outlook (a further 100bp hike in the Discount Rate – DR – penciled in which suggests full-year FY14E tightening of 150bp) does not include any impact of the sharp hike in power tariffs announced on October 01, 2013. In the above scenario, we anticipated CPI to cross the 9.0% mark in November 2013 and reach double-digits sometime around February 2014. Incorporating higher electricity prices though is a game changer, where electricity tariffs carry 4.4% weight in the overall CPI basket. We estimate that, post power tariff hike, CPI would cross the 10.0% mark as early as November 2013 with a preliminary November 2013 inflation outlook of 10.14% (vs. base-case November CPI outlook of 9.17% YoY).
All of which brings us back to the million dollar question on interest rates. Note October 2013 inflation will be the last reading before the next Monetary Policy Statement (MPS), which is due in November 2013 hence should carry significant weight for the equity market. Recent money market behavior suggests lower conviction of a ~100bp hike in the Discount Rate (currently at 9.5% after a 50bp hike in September 2013) in November MPS, where (1) 10-year PIB yields have come down by ~40bp during the course of October to 12.5-12.6% (from 12.9- 13.0% at the start of the month); and (2) State Bank of Pakistan (SBP) rejected all bids in the October 24, 2013 PIB auction, where 10-year PIB was being bid at implied yield of 12.59-12.84%. From our vantage point meanwhile, the risk of sharper and faster than eyed Discount Rate hikes is intact if CPI numbers come in on the higher end of the spectrum. With a potential higher-end FY14E CPI outlook of 10.3%, we flag the risk that our 10.5% DR target by June 2014 may prove too conservative where since 2000, Pakistan’s real interest rate has averaged +1.5%.