Morning Call about 1) Cooling inflation gives some flexibility to SBP – Arif Habib Limited

Karachi, January 06, 2014 (PPI-OT): 2) NSS rate hike; Banks unintended consequence bearer

According to Arif Habib Limited,

1) Cooling inflation gives some flexibility to SBP

1HFY13, period average under 9%

For the month of Dec-13, falling food prices (-3.3% MoM) cools off CPI inflation by 1.32% MoM to 9.18%YoY.Overall non-food prices continue its upward trajectory inching up +0.2%MoM to 9.3%YoY. This brings the period average headline inflation to 8.9%YoY versus 8.3%YoY last year same period. More importantly, Dec-13 inflation was lower than overall market consensus at 10.1%.

Perishable items: The segment that deflated overall price index
After recording a sequential rise for the past two consecutive months, food prices finally reverted. Perishable food items – contributes only +4.99% of the food basket, but has been very volatile in the recent months – tomatoes (53.83%), Potatoes (35.94%), Fresh Vegetables (30.59%) and Onions (18.07%) saw the biggest decline. This alone has caused an overall 1.3ppt impact on the overall index. Notably, early in Oct-13 and Nov-13, prices of similar perishable items increased to somewhat in similar manner.

However, food inflation will remain a threat
Arif Habib Limited believes this particular current trend in food prices is more cyclical, as structural supply and demand-side problems still exist. Higher input cost of production – fertiliser price distortion, rising energy cost – would translate into increased end consumer prices for perishable food. Henceforth, the prospect of having subdued prices ahead seems rather bleak.

Soft CPI gives SBP flexibility on policy rate but…
SBP will reveal its monetary policy review by the mid of Jan-13. Inflation coming off in Dec-13 would certainly provide some flexibility to SBP. However, having said that, Arif Habib Limited’s interest rate forecast remains contingent on seeing near upside risk to inflation–high base effect, higher food prices and to some extent tariff revisions. Sticking to Arif Habib Limited’s base case, inflation estimates stretch out in the average range of 11-11.5% YoY in 2HFY14 (FY14E: 10.0-10.5%); keeping Arif Habib Limited’s total policy rate hike of 50bps intact during 2HFY14.

2) NSS rate hike; Banks: unintended consequence bearer

NSS rate hike to mobilise additional non-banking fund
The government has recently revised the National Saving Scheme (NSS) rates by 60bps point, given the elevated rates on 3, 5, and 10 year Pakistan Investment Bonds (PIBs). While this may allow the government to increase its non-banking funding as such in FY13 almost 64% (or PKR 314bn) of the total federal receipts were raised through Saving Schemes. Moreover, the government has budgeted in a total of PKR 735bn or 32% of total federal receipts through saving schemes. Improved return rates should imply a better fund flows.

New rates on saving Scheme
Date   1-Oct-13   1-Jan-14
Maturity Link with PIB
Old Rates  New Rates   Change (bps)
Defence Saving (DSC)           11.61%    12.26%               65               10-Year
Bahbood Saving (BSS)           13.44%    14.04%               60                     -
Regular Income (RIC)           11.22%    11.88%               66                5-Year
Special Saving (SSC)           10.60%    11.40%               80                3-Year
Pensioners Account (PA)        13.44%    14.04%               60                     -
Saving Account (SA)             7.25%     7.75%               50                     -

Saving scheme differential to benchmark Pakistan Investment Bond(PIB)
DSC     10Yr(bps)      RIC     10Yr(bps)   SSC     10Yr(bps)
Jul-12   12.7%     61           12.4%          56  11.9%           69
Aug-12   11.5%     47           11.0%          53  10.7%           35
Oct-12   11.0%     44           10.6%          44   9.9%           58
Jan-13   10.8%     61           10.4%          59   9.7%           73
Jul-13   10.4%     57            9.5%          59   8.8%           64
Oct-13   11.6%    140           11.2%         135  10.6%          140
Jan-14   12.3%     49           11.9%          52  11.4%           44

Banks: The unintended consequence bearer
However, increasing the return rates and fund mobilisation through NSS entails a strong possibility of medium-term fund substitutions for banks fixed deposits and to certain extend foreign currency deposit. This has two implications for banking sector 1) this would allow a possible deposit flow out of the banking system, 2) banks will be forced to increase their return rates on fixed deposits. While this may protrude negative sentiment, however Arif Habib Limited thinks banks with extended branching network would remain somewhat protected.

PKRmn Total Dep.^   Fix^^  Fix/TD  Dep/Branch* Rates/3Yr   5Yr   10Yr    Branches
BAHL          370      85     23%        1,200      9.0%   9.3%   -           308
NBP         1,021     309     30%          775      7.4%   7.9%  8.3%       1,317
MCB           584      60     10%          492      7.9%   8.5%  9.1%       1,187
HBL         1,268     325     26%          823      7.4%   7.2%  8.2%       1,540
UBL           773     223     29%          596      8.9%   9.1%  9.6%       1,296
ABL           571     165     29%          652      7.0%   7.0%  -            875
BAFL          451     108     24%          957      7.8%   8.2%  -            471

But, marooning banks’ profitability seems unlikely
Arif Habib Limited thinks mid-to-small tier banks will have to increase their profit rates in order to keep the real rate of return (adjusted for inflation) positive. Whereas large-size banks with extended branch networking will remain somewhat protected or may see a slight rate hike. On profitability, increasing rates on fixed deposits will certainly push banks’ cost of deposit causing a further squeeze on NIMs. Bank AlHabib (BAHL) for instance offers a high rate on fixed deposit in order to keep its deposit base stable followed by United Bank Limited (UBL). While, Allied Bank Limited (ABL) and Habib Bank Limited (HBL) offers relatively lower profit returns. Based on above criterion, Arif Habib Limited thinks BAHL, BAFL and MCB will be the least affected. Moreover, in view of seeing a rate hike, Arif Habib Limited can see the additional mark-up income flowing into the overall banking sector.

Recommendation
At current prices Arif Habib Limited has a BUY recommendation for BAFL and UBL offering and upside of 37% and 16% from Arif Habib Limited’s target price of PKR 34 and PKR 135 respectively, by Dec-14. In addition Arif Habib Limited estimates a dividend of PKR 4/share and PKR 9.1/share in BAFL and UBL in Dec-14.