Macro Analysis /

Pakistan Strategy - Shift in economic policy narrows the path to recovery

  • Prudent policies are in question after the change in finance minister. Bond yields spiked and KSE100 volumes contracted

  • The PML-N is ascendant at PTI’s expense but the outlook on politics remains murky. Elections are due in twelve months

  • Valuations are very cheap but it is difficult to see rerating until the top-down outlook improves

Raza Jafri
Raza Jafri

Executive Director, Research

Intermarket Securities
3 October 2022

Risk aversion is back

The KSE100 shed 2.9% in September (7.8% in US$ terms), as the previous month’s exuberance ran out of steam. Domestic factors relegated the strength of the US$ and its global effect to almost an afterthought. The government’s position appeared to strengthen, but this increases the likelihood of populist measures, especially in the backdrop of post-flood relief. This does not automatically derail reforms, with the new finance minister affirming his commitment to the IMF programme, but does narrow the path to recovery. The jump in Pakistan’s bond yields, and thinner trading in equities amidst continued selling by local and foreign institutions, reflects this higher risk perception. Concerns are balanced against valuations that are comparable to the lows seen during Covid and the Global Financial Crisis. We believe the risk-reward is attractive through the cycle, but more clarity is needed on macroeconomic direction, especially after the change in finance minister.      

Watch Politics, Reforms and Debt Relief

  • PML-N ascendant It has taken about six months since the vote of no confidence for the government’s hand to strengthen more perceptibly. PML-N vice president Maryam Nawaz’s 2018 conviction in a foreign properties case has been set aside, enabling her to contest elections. At the same time, arrest warrants in an assets-beyond-means case for Senator Ishaq Dar have been suspended, paving the way for his return to Pakistan and the finance ministry. Although Imran Khan also saw relief in some of the cases against him, his legal troubles are not over, with the tone set early on in September after his comments on the appointment of the army chief were seen as too confrontational. The outlook on politics remains uncertain, and PTI may yet act on its warning to march onto Islamabad. Two other key checkpoints across the next twelve months include the appointment of the new army chief (November 2022) and general elections (Fall 2023).    

  • Daronomics v 2.0 Mr. Dar’s reputation precedes him, with the PKR beginning to strengthen even before his formal appointment as finance minister. Going by his 2013-17 stint in the same post, "Daronomics" entails a stable currency with an emphasis on lower interest rates. In this regard, the levy on petroleum has just been reduced by PKR5/ltr to PKR32/ltr and while the low Fx reserves (1.5 months import cover) grant little room to maneuver, there is immediate focus on administrative measures to reduce currency speculation. The sustainability of such policies within the ambit of the IMF programme is unclear. More positively, Daronomics also extends to improved efficiency - Mr. Dar is empowered and will likely look to accelerate investments from the GCC and relief on bilateral/multilateral debt. Going by precedence, we do not think any debt restructuring will extend to commercial debt.           

  • Valuations are attractive, even if high tax repeats Profits for the IMS Universe have plunged by 40%mom/9%yoy in 2QCY22, on the impact of the super tax introduced in the FY23 Budget. The government’s fiscal position is weak, especially following the floods, and the corporate sector remains vulnerable to repeat high taxation as the year progresses. Even if this happens however, valuations should still remain very attractive in our view. Nevertheless, it is difficult to see valuation rerating until the top-down outlook improves.       

  • For our top picks, we replace POL with OGDC. The new finance minister has been decisive in the past in tackling circular debt, and it is possible that he turns his attention to the energy sector quickly. Steps to alleviate circular debt should spell positives for the likes of OGDC, PPL and PSO in our view. In addition, MLCF makes a comeback in our top picks in place of ENGRO. While we still like ENGRO, we believe exposure to its subsidiary EFERT offers the same high dividend yield theme. Instead, MLCF should benefit from post-flood reconstruction, with a "build back better" narrative beginning to take shape.