Macro Analysis /

Pakistan Strategy: Temporary populism delays reforms thesis without derailing it

  • Domestic politics and the Russia-Ukraine crisis led the KSE100 lower in February. It still outperformed MSCI EM & FM

  • Reforms continue, backed by the IMF programme. Temporary populism such as lower fuel prices does not derail this thesis

  • Corporate profits are strong and valuations remain cheap. Pakistan is holding up despite the downturn in global markets.

Raza Jafri
Raza Jafri

Executive Director, Research

Intermarket Securities
28 February 2022

Key checkpoints fail to dislodge deeply entrenched caution

February saw the resumption of the IMF programme and Pakistan’s inclusion in the MSCI Frontier Markets 100 Index. However, these important checkpoints failed to enthuse the market, as investors kept an eye on domestic political developments. Trading activity remained dull at c US$60mn, but the results season invigorated bursts of activity in selected stocks. With the Russia-Ukraine conflict driving risk-off for equities, including in Pakistan, the KSE-100 ended up losing 2.0% in the month (down 2.4% in US$). This still outperformed both MSCI EM & FM though. Foreigners turned sellers again (primarily in Technology), but at a slower clip compared to the EM years. Going forward, higher commodity prices are a risk to the current account and inflation, but mitigating factors include the aforementioned IMF programme, the commencement of the Saudi oil facility (deferred payments), and the SBP’s willingness to look through near-term inflation.            

Watch monetary policy, politics & reforms   

SBP appears comfortable despite higher commodity prices

National CPI has spiked from 9.2% in October to 13.0% in January, and is likely to inch up further given the run up in global commodities. After increasing the policy rate by a cumulative 275bps to 9.75%, the SBP kept rates on hold in January and indicated it is willing to ignore near-term inflation in favor of FY23 outlook. This resolve could be tested come the next monetary policy announcement (due March 8th), with the recent T-bill auction seemingly suggesting money market expectations of a 25bps rate hike. For now, the SBP appears comfortable with existing monetary settings, as gleaned by its calm response to January’s record-high CAD print (US$2.56bn; of which c US$1.5bn is due to fully financed imports).

Reforms are ongoing but politics heating up

The push on reforms continues, not just under the IMF, which has added six new structural benchmarks, but also the government’s own initiatives. These include gas pricing on weighted average cost (energy reforms), a policy for IT/ITeS companies (beneficial for services exports & the current account), and wider rollout of health insurance (social protection). However, pressure is rising on the government, with the opposition seemingly unifying under the PDM umbrella to contemplate a no confidence motion against the Prime Minister. This is evidently resulting in some populist decision making, with the Prime Minister announcing lower fuel prices and electricity tariffs until the next Budget. So long as these are temporary measures, they do not derail our reforms thesis. Irrespective of politics, we argue that some key reforms will have lasting power, such as the move to a market-determined exchange rate or institutional strengthening at the SBP and NEPRA.

Headline corporate profits are strong

Pakistan Inc. continues to put out solid earnings, with our extended universe posting earnings growth of 37%yoy/7%qoq in the quarter ended December 2021. The strong yoy growth has been led by Banks and the Energy chain (ex-Power), and a positive outlook for both should continue to prop up headline corporate profits in Pakistan given their high weights in the KSE100. However, profits for sectors such as Cements and Autos may take an interim dip given headwinds such as higher coal prices and tighter auto financing.  

Too cheap to ignore

Pakistan faces challenges from the geopolitical situation (tough balancing act between global superpowers), weak macroeconomic buffers and domestic political noise. That said, we argue that these risks are already baked into valuations, with forward P/E of 4.9x at a steep c 40% discount to the 10yr average. For our top picks, we include UBL and TGL in place of BAFL and MLCF. UBL’s payout ratio may sustain at c 70% and its Middle East operations have turned the corner. TGL is growing quickly, has partnered with ICI, and offers exposure to the construction sector without the accompanied risks prevalent in Cements.