Macro Analysis /

Pakistan Strategy: Valuations sidelined (unfairly) on renewed tensions with India

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Intermarket Securities
    8 August 2019

    Following India’s decision to revoke Kashmir’s autonomous status, Pakistan’s civilian and military leadership held a meeting yesterday to determine Pakistan’s response. Some of the decisions that have come out of this meeting reportedly include:

    • Downgrading of diplomatic relations 
    • Review of bilateral arrangements
    • Suspension of bilateral trade
    • Taking up the issue with the United Nations

    As a first step in downgrading diplomatic relations, the Indian ambassador will be expelled while Pakistan’s ambassador will be recalled. So far, it is unclear what is meant by the review of bilateral arrangements given that multiple agreements exist pertaining to matters such as water sharing, visa issuances and communication & transport links, among others. 

    The suspension of bilateral trade is expected to have a small impact. In FY19, trade with India accounted for 1.3% of Pakistan’s exports and 3.0% of imports. However, after relations turned sour following the Pulwama incident earlier this year, this reduced to just 0.4% of exports and 1.8% of imports in 4QFY19. Cement exports, for instance, came to a complete halt in 4QFY19. Going forward, it is possible that inflation increases slightly given Pakistan imports some edibles from India, and Food has a 36% weight in the CPI basket. That said, we see little change to the SBP’s outlook for FY20f CPI (11-12%), and retain our view that interest rates have likely peaked. 

    While Prime Minister Khan has directed the armed forces to remain vigilant there has, importantly, been no directive to mobilize troops. This is a measured approach and we attach little probability to the chances of a direct military confrontation. That said, sentiment is being adversely impacted. The KSE-100 Index has fallen by 7.0% this week (including today’s move of more than -2.5% as we write), and is now trading below 30,000pts. Given continued local selling (mutual fund redemptions) and weak foreign interest, it is possible that the market continues to come off in the near-term. However, we flag that Pakistan’s valuations are more than 1 standard deviation below the long-term mean, while corporate profitability is also at a cross-cycle low. In our view, mean reversion on both fronts can drive strong outperformance vs. peer markets over the medium-term.