Pearl Securities Limited – Sector: Economy

Karachi, February 03, 2016 (PPI-OT): Monetary Policy and CPI

Key Features

As expected, the SBP has maintained policy rate at 6% for the next few months. DR remains unchanged at 6.5%.

Policy decision was taken in light of 1.) low expected inflation for FY16 (3-4% range), despite reversal trend, 2.) increasing private sector credit offtake and better LSM activity, as well as 3.) in support of local currency.

Monthly inflation inched up to 3.32% in the month of Jan’16, moderately greater by 13 bps against inflation of 3.19% in the previous month. Inflation is still lower by 56 bps against 3.88% recorded in Jan’15.

Cumulative 7mFY16 inflation stands low at 2.24% against rate of 5.72% in SPLY.

Main factors behind greater inflation are increase in the HWEGF basket (~29% weight) and reduced negative inflation in the Transport segment (~7% weight).

On the other hand, inflation of the Food and Beverage (F and B) basket (~35% weight) has declined to 1.21% (Vs. 1.44% in Dec’15) due to price decline in popular perishable items.

Policy Rate unchanged at 6%

The central bank has maintained status quo, as expected, by maintaining policy rate at 6% for the next few months. DR remains unchanged at 6.5%. Despite reversal in inflation trend, overall inflation for FY16 is still expected to remain on the low side, estimated in the range of 3%-4%. Inflation has been contained primarily on suppressed food and oil prices which may contain prices in other baskets as well. Oil price decline has been a significant factor in lowering inflation levels, where reduced transportation expenditure had a direct effect in containing consumer item prices.

Additionally, pickup in private sector credit, improved activity in LSM sector and stable external account further encouraged policy rate to be maintained at low level. SBP direction to stimulate private sector activity by reducing DR in accommodative environment has improved private credit offtake to Rs.340bn in 1H FY16, greater by 51% YoY against offtake of Rs.225bn in SPLY.

Large Scale Manufacturing (LSM) activity showed commendable growth of 4.4% in 5mFY16 against growth of 3.1% in SPLY. Better energy supply, low input prices and easier access to financing, amid low interest rates, all facilitated better activity in manufacturing.

Also FX reserves have improved to US$20.5bn (as of 22nd Jan’16) against level of US$18.8bn in Jul’15. External account outlook remains stable in the near term with the continuation of the EFF programme with the IMF, inflow from other sources as well as surplus of capital and financial accounts.

Jan’16 CPI inflation inches up to 3.32%

Inflation in Jan’16 increased moderately by 3.32%, lower than market consensus. Lower than expected growth was due to slowdown in prices of perishable food items which restrained growth in the F and B basket while upward pressure is noted through significant reduction of negative growth in the Transport segment and increase in the HWEGF basket.

As seen in the graph to the right, inflation in the Food and Beverage (F and B) basket reduced to 1.2% in Jan’16 against 1.4% in the previous month. This was due to negative growth in the perishable food sub-segment of -2.16% in Jan’16 against growth of 2.81% in the previous month. Strong price reduction is noted in some popular perishable goods such as Tomatoes declining by 38%, Potatoes by 29%, Onions by 14% and Vegetables by 5%, among others. The perishable food segment holds ~5% weight in CPI calculation and ~14% weight in the F and B basket.

Inflation in the heavy weight Housing, Water, Electricity, Gas and Fuels (HWEGF) basket increased by 5.01% in Jan’16 against growth of 4.97% in the previous month. This basket has ~29% weight in CPI calculation methodology. Increase in noted due to 2.28% increase in Water Supply cost and 2.03% increase in House Rent.

Strong reduction of negative growth is noted in the Transport segment of -1.80% against – 4.04% in the previous month. With ~7% weight in CPI, reduction of negative growth in the Transport segment has had a strong impact in increasing CPI inflation.