The Bell about CPI re‐composition bound to invite criticism – Elixir Securities Limited

Karachi: Change in CPI basket and calculation methodology yields a lower than expected CPI: FBS released Aug‐11 inflation numbers with a two week delay, stating CPI inflation at 11.56%, much below market expectation of 13.2%.

According to Elixir Securities, Aug‐11 inflation numbers used FY08 as base year, with revised weights based on FY08 expenditure survey, while calculation methodology of house rent index was also altered. Had the previous calculation methodology been used, Aug‐11 CPI inflation would likely have been reported at 12.6%. Weights and categories of SPI and WPI have also been altered, leading to revision in historical data.

Almost all of last 3 yr data points showing lower inflation would invite scepticism: FBS has revised down CPI inflation for FY09, FY10 and FY11 by 374bps, 163 bps and 26bps respectively to 17%, 10.1% and 13.7%. All but one of the 37 monthly data points revised show downward adjustment in inflation.

Key changes in CPI: 1) Weight of food items reduced by 551 bps to 34.83%, 2) Calculation methodology of house rent index changed to survey data of actual house rents, 3) Introduction of three new categories, 4) increase in number of cities covered from 35 to 40 and 5) increase in number of essential items from 374 to 487.

Rebasing and re‐composition is a routine exercise… Pakistan’s CPI was rebased in FY60, FY70, FY76, FY81, FY91, FY01 and FY08. China’s CPI has been recomposed twice since 2001, with the latest rebasing taking place in Jan‐11 envisaging 220 bps cut in food category weight, while Malaysia altered its CPI basket and Base in CY11, cutting food category’s weight by 110 bps.

…but reduction in food category weight is too steep: A steep 551bps reduction in weight of food group is too steep in Elixir Securities’ view, given the booming Chinese economy managed a reduction of mere 220 bps during five years ending Dec‐10, while Malaysia managed a reduction of 110bps during the same period. Food weight in Pakistan’s CPI at 34.3% is too close to Malaysia (30.3%), and China (31.8%); economies with much higher GDP/capita.

Category of “liquor and tobacco” indicates re‐composition is “not‐a‐home‐grown”, hurriedly done exercise: Inclusion of “liquor” was initially a surprise to us. However, further investigation revealed the categories of CPI are not home‐grown by FBS and rather copied from Malaysian CPI basket. This further adds to doubts regarding legitimacy of CPI. It is difficult to argue that the household expenditure survey for CPI should not have used categories in line with domestic consumption trends.

Likely lower CPI for Sep‐11 indicates further DR cut; but monetary easing is a risky bet in the current scenario: Base effect of post floods food price inflation would further pull down CPI inflation under 11% during Sep‐11 to Nov‐11. In view of talks of farewell to the IMF program, and absence of regular SBP governor, Elixir Securities’ base case estimate of 50 bps cut in Oct‐ 11 MPS seems conservative. However, Elixir Securities believes monetary easing, could be highly risky given uncertain outlook on the external account. Though CAB for Aug‐11 was well under control, trade deficit reported by SBP was USD455mn lower than that reported by FBS. Inflationary pressures still exists as 1% MoM run rate from Oct‐11 onwards would push CPI close to 14% by FY12 end, while 2HFY12 average would likely touch 13.5%.