Macro Analysis /

Pakistan Strategy - Reforms intact as IMF programme draws nearer

  • The KSE100 was weak in November on EM outflow and monetary tightening, which overshadowed the IMF staff level agreement.

  • Inflation is high and more Policy rate increases are likely, but a platform is in place for sustainable economic growth.

  • Pakistan can show a catch up rally vs. peer markets. The emergence of the Omicron variant does not alter this view.

Raza Jafri
Raza Jafri

Executive Director, Research

Intermarket Securities
30 November 2021

MSCI outflows dominate The KSE-100 lost 2.4% in November (down 4.7% in US$), with initial momentum evaporating in the face of sharply higher interest rates and foreign selling. The SBP raised the Policy Rate by 150bps, higher than street consensus by 50bps, while passive EM outflows accelerated in the last two weeks of the month, ahead of Pakistan’s formal downgrade to FM status. As a result, a key milestone - the staff level agreement with the IMF - was largely ignored. Although Pakistan still has to fulfill certain prior conditions (SBP Act and tax reforms via a “mini budget”), the resumption of the IMF programme appears almost certain. With event-driven foreign selling now over, and a platform in place for more sustainable economic growth, Pakistan equities are well placed to rebound in the near term.      

Watch IMF prior actions & MPS  

Reforms to continue The SBP reacted to a higher inflation outlook and an uncomfortably large current account deficit (easily tracking 3%+ of GDP) by increasing the CRR for commercial banks by 1% and raising the Policy Rate by 150bps to 8.75%. The rate increase was closely followed by the announcement of a staff level agreement with the IMF for programme resumption. Some of the prior actions Pakistan still has to complete before the IMF’s Executive Board sits down include (i) the passage of the SBP Act, which seeks to grant the central bank more autonomy, and (ii) the removal of GST exemptions, which can increase tax revenues by more than 0.5% of GDP. While allied political parties have aired grievances over the government’s performance, they have also recently backed PTI-led bills and should continue to do so, in our view. The resumption of the IMF programme will reinforce the reform process and improve the outlook for sustainable economic growth. 

Distorting FI flows are behind us

During Pakistan’s 2017-2021 stint in the MSCI EM Index, foreign institutional investors offloaded about US$1.7bn (net). More than US$140mn of this exited in November 2021, as passive EM funds sold down, distorting the KSE-100’s performance. With this burst of forced selling now over, the KSE-100 is well placed to rebound in the near term. This is despite the latest CPI reading of 11.5% (much higher than expectations), and likely continued monetary tightening in December, which in our view is already partly priced in. We reiterate that the FM classification does not affect our liking for Pakistan equities, which is based on continuing reforms, strong corporate profitability and attractive valuations.

Outlook: Room for a catchup rally despite the high CPI print

Macroeconomic uncertainty has significantly reduced and attention should turn back to the core theme of continuing reforms and sustainable economic growth. We see room for a catchup rally after Pakistan’s deep underperformance - in CY21td, the KSE-100 has shed 6.3% in US$ terms vs. a 16% gain for India, 23% for Bangladesh and 36% for Vietnam. The Omicron variant does not alter this view, with Pakistan well placed given c 60% of the adult population is fully vaccinated, the government’s strategy of targeted lockdowns, if the need arises, and the beneficial impact on the current account going by the earlier global lockdowns.  

Top Picks: HBL in for UBL, ILP in for MTL

Our recommended portfolio was flattish in November, thereby outperforming the Index. While we continue to retain Buys on both, we replace UBL with HBL in our top picks. Both banks offer similar themes and trade at similar valuations, but HBL offers faster profit growth and can rebound quickly with the end of passive EM selling. In addition, we take MTL out given strong chances that tractors may face a higher GST, which has historically hurt sales significantly. MTL is replaced by ILP where we like the latter’s strong growth prospects and high quality management.