Macro Analysis /

Pakistan Strategy - Ultra-cheap but little room for complacency

  • August saw the KSE100 gain 14.3% in US$, as confidence returned and the PKR recovered. Volumes rebounded too

  • The IMF programme has resumed, but floods complicate the recovery while politics still has the potential to jar

  • It may take until the new elections for a new cycle to start, but the risk-reward is already deeply attractive

Raza Jafri
Raza Jafri

Executive Director, Research

Intermarket Securities
30 August 2022

Rebound in August as confidence returns

With calls for Pakistan becoming "the next Sri Lanka" coming to an end, the KSE100 rebounded by 5.1% in August (14.3% in US$ as the PKR recovered its July losses). Daily trading activity doubled, albeit from a very low base, but foreign institutions chose to sell the rally, particularly banking stocks, with BAFL and NBP set to be dropped from FTSE tracking in mid-September. Devastating floods complicate the economic recovery without derailing it, with the resumption of the IMF programme providing support. Politics remains an area of concern, however, as PTI’s mass popularity comes up against increasing repression. We argue that the unquestionably cheap valuations already take care of the risks. Twelve months on, Pakistan should have a government with a fresh mandate, much lower inflation, and strong corporate profits. The risk-reward is highly attractive at current levels.      

Watch Politics, Floods and Populism

PTI up against it

PTI’s resounding win in the Punjab by-elections and subsequent success in the chief minister elections now seems distant. August has seen the PTI come under the scanner for allegedly receiving prohibited foreign funding. Imran Khan himself faces charges of terrorism and contempt of court emanating from a firebrand speech, while his close aide has been arrested on charges of sedition and incitement to mutiny. Although the PTI retains nationwide popularity, evidenced by its easy win on the vacant NA-245 seat in Karachi, the party finds itself increasingly hemmed in. PTI being successfully muzzled would end speculation of early elections. This would ensure politics does not disrupt the ongoing economic recovery, enabling equities to continue their bounce. It would, however, also mean a lost opportunity to win back civilian space and challenge the status quo.

Floods complicate the recovery without derailing it

The IMF programme has successfully resumed with a topped up size of US$6.5bn, and it will now run until June 2023. However, recovery may be complicated by the devastation caused by the worst floods since 2010, with the initial loss to Pakistan’s economy estimated at more than US$10bn (3% of GDP). We see negative near-term implications for GDP growth, inflation and the twin deficits. While the SBP took a pause in August, it is possible that the higher near-term inflation leads to another round of monetary tightening under new Governor Jameel Ahmed, particularly with the IMF emphasizing the need to retain a “proactive and prudent monetary policy”. That said, going by 2010’s precedence, the floods may only have a minimal impact on corporate profitability (see: Special Section – 2010 floods), possibly because the bulk of the affected population (30mn+) operates outside the formal economy. This of course does not detract from the urgent need to generate donor support, and efforts to this end have begun to gather momentum. 

Valuations are deeply attractive

The finance minister has weathered criticism, including from his own party, to take the tough steps necessary to resume the IMF programme. Despite his push, compliance with what has been a stop-start programme will likely face challenges. For instance, the IMF has highlighted the need to stick to the FY23 Budget, even as one of its key components, the fixed tax on retailers, has already been deferred by a year. That said, while it may take until the next elections for a new cycle to begin in earnest, current valuations indicate an attractive risk-reward. This is backed by corporate action, with LUCK following MLCF in announcing a share buyback.     

Our portfolio of top picks gained 10.0% in August, outperforming the KSE100 by 4.9%. We drop HUBC, which did not announce a final DPS, and replace it with ENGRO which offers exposure to multiple sectors, including power, and has room to surprise on cash payout. PSO, with triggers lined up in the shape of margin revision, comes in for MTL which has rallied strongly this year (twin bonus issuances).