- Pakistan has reached IMF staff-level agreement to resume the EFF program that has been stalled since last April
- This will resume the economic reforms and also cement the present balance of payments strength
- The market will continue to rally as Banks and E&Ps may finally join the rise
Pakistan has reached a staff-level agreement with the IMF to resume the EFF Program (suspended since the onset of Covid-19 pandemic). The review is pending the IMF Board’s approval, following which US$500mn will be released to Pakistan (potentially by April). Recall that Pakistan received c.US$1.5bn before the pandemic, out of the total US$6bn program.
This is a positive development for the economy, as it will help resume the reforms process and also cement the balance of payment stability that Pakistan has achieved in the past few months. From the market’s standpoint, the event was expected given the SBP’s guidance and the recent power tariff hike (an IMF precondition to resume the program). Nonetheless, the fact should help to extend the recent market rally (up c.7% CY21td).
Many positives for the economy
More capital inflows: Besides the IMF’s own disbursements, Pakistan is likely to quickly tap global capital markets for another Eurobond issue (potentially of US$2-3bn), as the program resumption and near-zero interest rates across the developed world make it an opportune time to do so. Given that domestic interest rates are likely to start rising by mid-2021, foreign investment in government securities may also revive (Pakistan had received c.US$3.4bn before the pandemic, which left immediately at the outbreak). Program resumption can also lead to early materialization of committed flows from other multilateral agencies (ADB and WB), in our view. All these will help to build forex reserves further (c.US$13bn presently with the SBP, equivalent to c.3mth import cover) ahead of typically hefty debt repayments by May-June. It is thus possible that the PKR continues its recent appreciation versus the US$ in the near term.
Energy sector reforms to continue: The recent power tariff hike (by 15% on average) will enable the government to collect more money to retire the outstanding circular debt (in concert with the cash injection agreed with the IPPs) and stall the buildup in future. The IMF’s press release also hints at similar measures to revitalize the power transmission & distribution network as taken in the previous IMF program (2013-16), which proved efficacious in containing the issue. These can include direct management interventions by the government in distribution companies and other key power sector entities.
Potential fiscal measures: These can include keeping expenditure moderate, where the government is likely to continue incentivizing the private sector to support infrastructure development (a more sustainable approach in our view, compared to a public-sector led effort). There are hints at some changes to corporate taxation – going by earlier news reports, this could entail removing certain tax exemptions but details are lacking at this point and we await further clarity. In general, we believe the resumption of the IMF program will add confidence to Pakistan’s economic recovery and lead to an improved medium-term outlook, especially as corporate profitability growth is strong enough to absorb an enhanced taxation scope.
Regulators to attain more autonomy: This is especially likely in the case of regulators of the banking (SBP) and energy sectors (NEPRA and OGRA). Note that the government had commenced work on this target before the pandemic. We think that passing amendments in these laws will become easier following the upcoming Senate elections (3rd March) – in which also PTI government can attain majority (thus majority in both the Houses).
Monetary policy to change May onwards: We think that the resumption of the IMF program makes the prospect of interest rate increases more likely (policy rate unchanged since June 2020); the first increase can take place in May 2021, in our view. This will be supported by potentially low double-digit inflation in some months (because of recent power tariff hike), and monthly imports close to US$4.5bn.
Market impact: Underperforming sectors can catch up
Despite being up c.70% since March 2020, the KSE-100 still trades at a forward P/E of 7.3x, much lower than its long-term mean level of close to 9.0x. This is largely because the market has underappreciated Banks and E&Ps during the rally (the latter despite the c.50% rally in international oil prices since Nov 2020). We think the key beneficiary sectors of the resumption of IMF program will be Banks and Energy sector stocks.
Energy sector: The E&Ps, some OMCs, gas utilities and IPPs will be key beneficiaries because the program resumption will mean more reduction in circular debt and better cash-flow positions across the Energy chain. We do not rule out the start of long-term solutions such as privatization of some power distribution companies.
Banks: A reversal in the interest rate cycle may commence by mid-2021, but the banking sector may finally begin to show improved price performance in advance of this due to an improved economic outlook.
Cyclicals: Potential PKR appreciation in the near-term carries positives for cement, auto, steel and other cyclical sectors, but the prospect of interest rate increases by mid-2021 can partially offset the benefit. Cash-rich companies such as INDU and LUCK will benefit from higher interest rates as well, but we do see room for a pivot into value stocks, especially from 2QCY21 onwards.
All in all, the event strengthens our view that the Pakistan market is on course towards setting a new all-time high level for the KSE-100 Index, as market confidence on macroeconomic improvement will be reinforced, while the Index heavyweights Banks and E&Ps may now also begin to perform.
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