A difficult June
The FY23 Budget saw the government attempt to widen the tax net, but the brunt eventually fell on the existing narrow tax base in the shape of higher corporate and personal taxes. The KSE100 shed 3.6% (6.6% in US$), with turnover thinning out even further. Foreign institutions and local insurance companies remained aggressive sellers. Pakistan is inching closer to the IMF programme but investor confidence remains low due to a sticky current account deficit, and ugly inflation prints around the corner. That said, we believe risks are largely in the price, with default likely be avoided as the IMF agreement draws near.
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Inching closer to the IMF programme
Pakistan has significantly reduced energy subsidies and sharply raised direct taxes. The 7th & 8th IMF reviews are reportedly being combined and Pakistan could receive c US$2bn upon programme resumption, which will likely come to pass in July in our view. The FY23 Budget attempted to widen the tax net on real estate and retailers, but ultimately could not avoid further burdening the narrow tax base. Most large corporates will now face additional 10% tax in in 2022, which reduces to a permanent +4% in subsequent years. Improved fiscal discipline reduces the load on the monetary side but the SBP could yet raise rates in the July 7th monetary policy, with the next inflation print expected north of 18% and international oil prices failing to come off. We expect an increase of 100bps, which will take the Policy Rate to 14.75%. This may be the last rate hike of the cycle though.
Improving relations with the West
Chinese commercial banks have recently disbursed loans of US$2.3bn, negotiations are underway with Saudi Arabia to enhance the deferred oil payment facility, and UAE is reportedly interested in acquiring stakes in state-owned entities listed at the PSX. Progress includes the appointment of a new US ambassador to Pakistan for the first time since 2018, the visit of the German foreign minister, and a positive outcome in the recent FATF plenary with exit from the grey list looking likely subject to on-site verification. A European Union mission also reached Pakistan last week to assess GSP+ compliance, and the broader improvement in relations with the West should help Pakistan’s case in our view. We thus assign little probability to Pakistan procuring oil from Russia, even though local refineries have been asked to assess suitability, with political considerations likely to win out over economic ones.
Risks largely in the price
The government is digging in, going by its increasing willingness to take tough decisions and secure the IMF programme. While coalition partners such as MQM have expressed discontent at the results of local body elections in Sindh, and PML-N rule is vulnerable in Punjab, it is difficult to envisage the coalition fracturing at this stage. Imran Khan is a lot quieter but remains a uniting factor for the ruling parties, no matter their disparate nature. For the economy, stabilization measures are underway and Moody’s decision to downgrade Pakistan’s outlook to Negative has not been matched by the other major credit rating agencies. Corporate profits will hurt in the near-term, owing to the 10% super tax for 2022, but the impact on recurring profitability is modest. On market cap to GDP, Pakistan is cheaper than its Covid low and nearly as cheap as its trough during the global financial crisis.
We remain positive on the KSE100 but picks turn more defensive
We turn more defensive and drop MLCF and TGL in favor of POL and MTL. MLCF’s ongoing share buyback is nearing completion (c 20mn of 25mn shares already bought), POL should announce a strong dividend with upcoming results, and the feared GST increase for tractors has not materialized (GST has instead gone from 5% to zero).