Economic Review

Contents
Balance of Payments - June ’09 Deficit Up 1
Rupee Depreciation - End of the line? 2
Inflation - CPI Down, SPI Resilient 3
Power Crisis - Assessing the Impact 4
Global Economy 5

Saad Hashemy
Research Head
+92 (21) 9033-2241
saad.hashemy@ubl.com.pk
Syed Abdullah Hasan
Research Analyst
+92 (21) 9033-2045
syed.abdullah@ubl.com.pk
Muhammad Shoaib Khan
Research Analyst
+92 (21) 9033-2604
k.shoaib@ubl.com.pk

UBL Research
June 22, 2009
www.ubl.com.pk
All rights reserved. UBL Research 2009
 Economic Review

July 22, 2009

Balance of Payments - June ’09 Deficit Up

Table 1 – FY09: Balance of Payments Performance June’09 – CA deficit offset by financial inflows
FY08 FY09 Change
BoP data for June’09 depicted a USD635million deficit in the
Current Account (13,866) (8,861) 5,005 current account, due largely to an unprecedented increase of
Exports 20,427 19,222 (1,206) USD900million in the monthly import bill. Whilst exports (up
Imports 35,397 31,716 (3,681) 21%
1% MoM) and remittances (USD735million) depicted healthy
Remittances 6,451 7,811 1,360 increases on a monthly basis, the change in imports reflected a
Services Balance (6,457) (3,231) 3,226
one-time
time deviation from the general trend. A build-up
build in oil
Financial Account inventories at higher international oil prices contributed
8,135 5,010 (3,125)
FDI
towards an increase
ease of USD266million in the import bill.
5,335 3,697 (1,638)
However, a surprising increase of USD248million was witnessed
FPI 36 (1,093) (1,129)
in CKD car imports, which have averaged below USD60million
Government
1,766 1,982 216 since FY07.
Disbursements
Gross SBP Reserves 9,385 9,846 461 FY10 Outlook – Oil prices remain key
IMF Credit (173) 3,691 3,864
Average Oil ($/bbl)
Our BoP outlook for FY10 remains cautious based on the
90.04 75.17 (14.87)
country’s dependence on imports. We are of the view that since
Source: SBP
the import base is highly diversified, demand management is
Chart 1 – Five-year average trade composition (FY04-FY09)
FY09) the best short-term
term solution to quell imports. However, in FY10,
pro-growth
growth policies are likely to dominate, hence, oil prices will
Food Group remain the key driver for import growth in FY10. With an
Imports
Machinery Group average oil price of USD70/bbl,
D70/bbl, we expect imports to reach
USD29billion in FY10.
9% 10% Transport Group
2%
Chart 2 – Rupee Depreciation & Textile Export Growth
7% Petroleum Group
18% Textile Group 30% 30%
25% 25%
Agri. & Other 20% 20%
16%
Chemical 15% 15%
4% Metal Group 10% 10%
5% 5%
5% Miscellanous Group 0% 0%
-5% -5%
26% All Others -10% -10%
-15% -15%
FY05 FY06 FY07 FY08 FY09
Exports
4% 12%
Textile Export Growth (LHS) USD/PKR Depreciation (RHS)
Food Group
23%
Textile Group Source: SBP, UBL Research

Other Manufacture An export base tilted towards low-value

value income elastic products
All Others leaves export performance for FY10 subject to recovery in
global demand. Secondly, whilst depreciation typically bolsters
a country’s export base, inclusion of imported goods in our CPI
55% basket (40%
40% Food, 14% Energy) leads to an incidence of
‘imported inflation’ in Pakistan. We therefore expect export
Source: SBP,, UBL Research growth to remain flat under USD20billion in FY10.

1|UBL Research
 Economic Review

July 22, 2009

Rupee Depreciation - End of the line?

Table 2 – Average monthly payment flows in FX Market FY09 During our monthly review of the economy in June’09, we
USD Millions Inflows Outflows pointed out a strong possibility that the exchange rate could
cross the USD/PKR85 level by January’10. To this effect, signs of
Petroleum Products 87 798
early weakness became evident as the rupee depreciated by
Furnace Oil - 160
1.5% against the dollar on an intra-day basis during July’09.
HSD and Refined
- 292 Whist there is still optimism surrounding the expected foreign
Products
inflows from FoDP to the tune of USD2billion for FY10, we
Crude Oil - 347
believe that despite these inflows, structural issues in our
Machinery - 415
Balance of Payments will remain the key driver for the exchange
Automotive - 82
rate in the absence of SBP intervention whilst Pakistan remains
Textiles 815 110 under an IMF program.
Chemicals - 403
Metals - 170
Daily payment flows
Other Import Payments 444 Actual intra-day movement in the USD/PKR rate is a function of
Food Export / Import 234 315 the size of the FX market and expected daily payment flows.
Other Manufactures Export 293 - Based on payment flows in FY09, our estimates suggest that the
Remittances 651 -
weakness in the rupee is driven by a fundamental payment
deficit averaging USD11million on a daily basis.
FDI 309 -
FPI - 88 Inflation differentials favor depreciation
Government
Disbursements
168 - In theory, the quantum of PKR depreciation should ideally
Monthly Payment Flow 2,557 2,825 follow the trend of prevailing inflation differentials between the
domestic economy and major trading partners.
Daily Payment Flow 98 109
Source: SBP, UBL Research Our estimate of the inflation differential between Pakistan and
major trading partners suggests that domestic inflation
Chart 3 - Trade-weighted inflation differential with EU and US
remained the key driver for movements in the exchange rate
25% 85 during FY09. We believe that this year’s depreciation reflected
80
20%
75
the cumulative macroeconomic adjustment required since FY04.
15% 70 Between July’04 and July’08, Pakistan’s trade-weighted
10%
65 differential averaged 5%, suggesting a required depreciation of
60
20% in the USD/PKR whereas PKR depreciation was only 9%
5% 55
50 over this period.
0%
45
-5% 40
Presently, our estimates show that the trade-weighted inflation
differential has fallen from a peak of 23% in October’08 to
Dec-03

Aug-05
Jan-06
Jun-06

Dec-08
Jul-03

May-04
Oct-04
Mar-05

Nov-06
Apr-07
Sep-07
Feb-08
Jul-08

May-09

average about 20% for FY09 whereas actual rupee depreciation

reached 25% in FY09. We estimate that rupee remains
Inflation Differentia (LHS) USD PKR (RHS) overvalued by 5%-6% as of May’09 and hence believe that there
Source: SBP, UBL Research
could be further room for depreciation based on inflation
differentials with trading partners.

2|UBL Research
 Economic Review

July 22, 2009

Inflation - CPI Down, SPI Resilient

Chart 4 – MoM increase in CPI composition (June ‘09) June ’09 CPI includes higher POL prices
3.5% The CPI figure for June’09 was higher than han expected at 13.13%. An
3.0% st
2.5% increase in oil prices effective from July 1 was retroactively
2.0% incorporated in June’09 ’09 CPI calculation resulting in 3.1% MoM
1.5%
1.0% inflation for the transportation segment of the CPI basket.
basket As per GoP,
0.5%
0.0% the month of August could include a slight reduction in oil prices,
which would be reflected in July’09 CPI figures. Based on this change,
Food

Others
House Rent

Fuel & Lighting

Transportation

we expect YoY CPI inflation for July’09 to reach close to 11.0%.

Chart 7 - Trend in CPI Inflation

30%
25%
Source: Federal Bureau of Statistics 20%
15%
Chart 5 - Trend in SPI Inflation 10%
5%
16.0% 1.60% 0%
14.0% 1.40%
12.0% 1.20%

Dec-08
Jul-08

Sep-08

Oct-08

Nov-08

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jul-09
Aug-08

Jun-09
10.0% 1.00%
8.0% 0.80%
6.0% 0.60%
4.0% 0.40%
2.0% 0.20% Source: Federal Bureau of Statistics, UBL Research
0.0% 0.00%
SPI Inflation resilient at 9.93% in July’09
30-Apr
7-May
14-May
21-May
28-May
4-Jun
11-Jun
18-Jun
25-Jun
2-Jul
9-Jul
16-Jul

The sensitive price index (SPI) follows retail prices for different income
groups to gauge inflationary pressures. On a weekly basis, SPI has
YoY Change (LHS) WoW Change (RHS) continued to increase, depicting the impact of a general rise in
inflationary expectations and periodic supply bottlenecks.
bottlenecks For July’09,
Source: Federal Bureau of Statistics
SPI inflation fell from double-digits to 9.93%.
9.93% Whilst base effect
Chart 6 - Composition of SPI for the lowest income group calculation drives inflation lower, weekly price
p increases in the SPI
basket are likely to become apparent in higher
hig CPI inflation over time.
4%
12%

10%
FY10 – Inflation to remain in double-digits
double
According to SBP, average inflation for FY10 is expected to reach 9.5%.
On the other hand, IMF’s forecast (as of April’09) places FY10 average
inflation at 6.0%. However, our outlook for inflation remains
75% moderately bullish based on the view that supply-side
supply inflationary
pressures remain active. Assuming the power tariff increases as
Food Energy & Communication expected (see p.4, Table-3) and accounting for a seasonal increase in
Consumer Items Apparel food prices during Ramadan next month, month our forecasted average
inflation for FY10 lies in the vicinity of 11.50%-12.00%.
11. Based on our
Source: Federal Bureau of Statistics outlook for inflation, we expect a 100-150
150bps discount rate cut in the
th
Monetary Policy Statement due to be released on 25 July’09.

Outlook –Beyond FY10

Since the interest rate cycle is likely to remain aligned with inflation
until the economy is out of the woods,, we have extended our forecast
horizon up to FY12. Our estimates show that average inflation is likely
to remain close to 11.0% % for FY11 and 10.8% for FY12 under the
primary assumption that month-on-month month inflation will average
approximately 0.8%-0.9%
0.9% during FY11 and FY12.

3|UBL Research
 Economic Review

July 22, 2009

Power
ower Crisis - Assessing the Impact
mpact

Chart 8 – Power Sector Supply/Demand Scenario GDP growth could be affected by up to 1%

MW MW The prevailing power crisis that is affecting all major business centers
24,000 100
of the country portrays a dismal picture of the country’s power sector
21,000 (600) that remains crippled with inefficiency and power shortfall. As per
Private Power and Infrastructure Board (PPIB), power demand is
18,000 (1,300)
estimated at 17,824MW, while total availability is 15,225MW, thus
15,000 (2,000)
leaving a gap of approximately 2,600MW.
Major
ajor share of power sector consumption is concentrated in the
12,000 (2,700)
domestic & household segment (46%), followed by industries (28%).
FY09 FY10E FY11E FY12E
Large scale manufacturing sector, which accounts for approximately
Supply (LHS) Demand (LHS)
Surplus/(Deficit) (RHS) 12% of GDP was down 7.7% during FY09. A major reason cited for this
decline was the power crisis during FY09, which has now magnified
Source: PPIB
with the start of FY10. We are of the view that the ongoing
o power
crisis could potentially affect GDP growth by 0.5%-1.0%,
0.5% putting the
Chart 9 – Power Sector Demand Composition GOP estimate of 3.3% growth for the year likely in jeopardy.
Table 4 – GDP sensitivity to large scale manufacturing decline
7%
Domestic
FY09 FY10 Sensitivity
8%
LSM Decline -8% -5% -10% -15%
12% Industrial
46% GDP Impact -0.9% -0.6% -1.2% -1.8%
Agri
Comm. Source: UBL Research & Pakistan Economic Survey

Others
28%
Tariff hike and resolution of circular debt
Ministry of Water & Power has announced an increase in power tariff
of up to 24% % in three phases, beginning October 01, 2009 to bridge
Source: Pakistan Energy Year Book
the generation cost (PKR 8.25/kWh) and consumer tariff (PKR
Table 3 – Timeline of Power Tariff Increase 5.45/kWh) shortfall (PKR -2.8/kWh). This measure is in line with the
understanding reached with International Financial Institutions (IFIs)
(IFIs
to phase out subsidy on power. Meanwhile,
Meanwhile circular debt resolution is
Tariff Revision
in progress and government has registered Power Holding Company
October 01, 2009 8-10%
Limited (PHCL) aimed to settle PKR 216 billion of power sector
January 01, 2010 5-6%
liabilities from generation companies (GENCOs) & distribution
April 01, 2010 5-6% companies (DISCOs).

Source: Ministry of Water & Power Bridging the Gap

The GOP, in an effort to tackle the power crisis, has opted for rental
power units, which are expected to start generating approximately
3,000MW of electricity by December 2009. Further, the GOP has laid
claim that
hat the country’s power crisis will be resolved by this measure.
We are of the view that infrastructural bottlenecks, transmission &
distribution losses and higher oil prices, which would raise generation
costs and limit thee country’s ability to pay will continue to drag down
the sector in the short to medium term.

4|UBL Research
 Economic Review

July 22, 2009

Global Economy

Chart 10 - Trend in Commercial Bank Reserve Balances in US US: Inflation Outlook

1,000,000 Whilst the Fed continues to talk down the threat of inflation, it
800,000 is undoubtedly concerned about the monetary transmission
600,000 mechanism. Our analysis (Chart 10) of periodic data from the US
400,000 Federal Reserve indicates that lending to financial institutions
200,000
from the US Fed have been used primarily to bolster reserve
balances since October’08. Whilst these measures have helped
-
to stabilize money markets, evident in the decline in overnight
US Libor rates to 0.23% as of 20th July’09 (Chart 11), it seems
that lending to the general economy has also flat-lined. The M2
Excess, NSA
Required multiplier has declined from 9.23 times in June’08 to 4.98 times
Total Borrowings from the Federal Reserve by June’09, reflecting a substantive deterioration of monetary
Source: US Fed, UBL Research transmission (Chart 12).

Chart 11 - Overnight USD Libor rates In simple terms, no lending means no growth. However, a rapid
decline in commercial bank reserve balances over the last two
0.8%
0.7% months suggests that the credit logjam is finally beginning to
0.6% clear. We believe that a drawdown in reserve balances and
0.5%
0.4% resumption in lending will be the trigger for the Fed to tighten
0.3% monetary policy, which may take another two to three quarters
0.2%
0.1% until labor markets stabilize. Inflation will remain low until a
0.0%
revival in monetary transmission allows credit to flow into
Dec-08 Feb-09 Apr-09 Jun-09
markets where it is needed.
Source: US Fed
UK: Interest Rate Outlook
Chart 12 – US Money multipliers have declined by nearly 50%
Currently, the Bank of England (BoE) is following an interest rate
10.0 “neutral” stance, that is, real rate of return is zero. However, as
8.0 the ‘Great Recession’ slowly starts to subside (from 2010
6.0 onwards), interest rates in the UK will most likely pick up.
4.0 Historically, going back to 1991, the real rate of return in the UK
2.0 has hovered around 4% on average. However, according to BoE,
- the general trend in lending remains weak. Moreover, UK CPI is
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08

Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09
May-09
Jun-09

expected to remain in the vicinity of 1.5%-2.5% till end-June

2010. We therefore do not expect real interest rates to drift
M1 M2 towards their historical average before this time.
Source: US Fed Chart 13 – BoE’s shift to a neutral policy stance will allign interest rates with inflation

15.00%

10.00%

5.00%

0.00%
Jun-91
Jun-92
Jun-93
Jun-94
Jun-95
Jun-96
Jun-97
Jun-98
Jun-99
Jun-00
Jun-01
Jun-02
Jun-03
Jun-04
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10

12M UK Libor CPI Inflation

Source: Bank of England, Bloomberg

5|UBL Research