Implications for Pakistan
The Taliban takeover in Afghanistan has several unanswered questions, key among them are the shape of the future Afghanistan government, its acceptability to the international community, and whether the promises made by the Taliban will be kept, particularly the amnesty to surrendered security forces and government workers.
While we await clarity, we discuss possible implications for Pakistan’s trade, economy and security conditions. Of immediate concern is the impact on trade (currently disrupted) and possible influx of refugees. Of medium-term importance is the impact on Pakistan’s security conditions, with the hard-fought gains over the last five years vulnerable to threats from entities such as the Tehreek-e-Taliban Pakistan (TTP).
The knee-jerk reaction from the markets was negative. The KSE-100 shed 0.5% on Monday while Pakistan’s international bonds were the worst performing among EM peers. There are certainly valid security concerns, but we flag that valuation multiples already seem to be pricing in this risk while the government’s commitment to the reform process remains intact.
Pakistan exported goods worth c US$1bn to Afghanistan in FY21, less than 4% of total exports and just 0.3% of GDP. More than half of this is food commodities but chemicals, pharmaceuticals and packaging material are also exported. Trade started to decline a few weeks ago, as the Taliban rapidly advanced across Afghanistan and borders closed, and is likely at a standstill now. Given the small size of the Pakistan-Afghanistan trade, the impact of any prolonged disruption to trade on most listed Pakistani companies is marginal. Instead, there may be grounds for Pakistani exports to increase once trade does resume, with Pakistan likely to recognize a government that is either led by the Taliban or includes them.
Exports to Afghanistan have been on a continuous decline in the past 10 years – from nearly US$2.0bn in FY11 to less than US$1bn in FY20. If exports to Afghanistan do increase, it is possible that the cement sector is a key beneficiary (Pakistan exported 4.7mn tons of cement to Afghanistan in FY11 vs. just 2.5mn tons in FY21). Moreover, in the medium to longer term, provided Afghanistan remains stable, it is possible that Pakistan is finally able to link-up with the Central Asian Republics in a trade and energy corridor, a vision that has been in place since at least the 1990s.
More than 3mn Afghan refugees are reportedly in Pakistan, most of whom are part of the local economy. That said, Pakistan has expressed reluctance to take on more refugees, reportedly citing a cost of US$2.2bn over three years to provide refuge to an estimated 700-800k displaced Afghans. As a percentage of GDP, this is lower than what European countries have spent on asylum seekers but similar to the US spend on resettlement programs. Given Pakistan’s economy remains under an IMF program (US$6bn), the fiscal deficit is a high 6-7% of GDP and Covid-19 remains relevant, international aid may be necessary to accommodate such an influx, should the need arise. Even so, Pakistan may look to restrict any refugee intake to border camps, similar to what Iran has done, particularly as the national security adviser has reportedly flagged the risk of TTP militants slipping into Pakistan in the guise of refugees.
Pakistan has delivered impressive and hard-fought gains on the security front in the last five years and a deterioration in security conditions is not a given. The inclusion of the Taliban in any future Afghan government may arguably reduce risk for Pakistan’s security if the Taliban stay true to their word of not letting Afghan soil be used by transnational terrorists. This may help prevent entities such as the outlawed Tehreek-e-Taliban Pakistan (TTP) from making a meaningful comeback, particularly as the border with Afghanistan is now almost fully fenced, manned by regular Pakistan army troops instead of paramilitary forces. That said, some increase in terrorist incidents may be unavoidable - the border fence has yet to be tested and the army’s spokesperson recently outlined the threat from sleeper cells. Deteriorating security conditions risk a slowdown in economic growth, with CPEC projects being especially vulnerable. This was aptly illustrated by last month’s suicide attack on workers travelling to the Dasu dam site, which enraged the Chinese and temporarily halted work on the project. On the flipside, the obvious buy-in from China may help dispel future security threats to CPEC projects emanating from Afghanistan. The recent visit of a high-level Taliban delegation led by Mullah Baradar to China reportedly discussed a separatist Uyghur group operating out of Afghanistan, and it is possible that this pressure extends to shared China-Pakistan interests such as CPEC (and by extension the TTP) as well.
The initial reaction of the KSE-100 to the Taliban takeover was negative, with the Index losing 0.5% on Monday (at its low it was down 1.1%). If uncertainty persists in Afghanistan, it is possible that this decline extends in the near term. That said, we continue to believe that Pakistan’s reform story remains intact, backed by a stable government, and that dips would represent accumulation opportunities. This thesis remains intact even if security conditions deteriorate to an extent, with valuation multiples already near levels seen in the 2009-2012 period when terrorism incidents peaked (market capitalization to GDP is presently c.16% vs. an average of about 17.5% across 2009-2012).
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