Macro Analysis /

Pakistan Strategy - Watching politics with bated breath

  • The KSE100 was flat in October (+4% in US$), with politics offsetting positives on FATF and the current account

  • Political tension is high as Imran Khan has launched his march onto the capital, but cheap valuations balance the risks

  • Key events in November include possible rollover of bilateral debt (KSA / China), and appointment of the new army chief

Raza Jafri
Raza Jafri

Executive Director, Research

Intermarket Securities
31 October 2022

Politics overshadows multiple positives

The KSE100 was up for most of October, hitting a high of c 42,350pts, before politics dragged the Index to a flat close for the month (+4% in US$). Imran Khan has commenced his march onto Islamabad in a bid to galvanize public support and force early elections. However, his rift with the army arguably makes his return to power more difficult. The uncertain political backdrop has overshadowed positives such as the much-awaited exit from the FATF grey list, continued improvement in the current account, and unchanged interest rates for the second straight monetary policy. In general, we think top-down concerns are balanced by ultra-cheap valuations (3.7x forward P/E), backed by strong corporate profitability. It is possible that politics dominates sentiment in the next few weeks, but we reiterate that the risk-reward is highly attractive, especially across the medium-term. Mobilization of support from Saudi Arabia and China, in the footsteps of ADBs recently disbursed US$1.5bn loan, can help rebuild Fx reserves quickly and act as a catalyst.  

Watch Politics and Support from Saudi Arabia / China

PTI leaves for the capital, again PTI’s march is scheduled to enter the capital next week, with early elections being the key demand. Imran Khan is no stranger to marches and sit-ins, but this one comes in the backdrop of his public rift with the army, which has faced blame after his ouster. There is no doubt that Mr. Khan is very popular – he won on 6 out of 7 National Assembly seats in the by-elections held two weeks ago – but this only makes the ruling coalition even more wary of calling early elections. Mr. Khan’s uphill task in returning to power will likely be compounded by continuing legal troubles where his recent, albeit toothless disqualification by the Election Commission (for unlawfully selling state gifts), is a reminder of the challenges. Risks emanate from possible law & order deterioration once the march enters Islamabad.

Near-term checkpoints include the appointment of a new army chief in November. On the bigger picture, (i) while the army has vowed to be apolitical, a wider berth to civilian space may only materialize gradually at best, and (ii) Pakistan-US relations remain circumspect (President Biden’s throwaway statement on the security of Pakistan’s nuclear weapons was walked back by the State Department, but it is still reflective). 

Bilateral support can inject confidence Finance Minister Dar backtracked on the reduction in the Petroleum Levy following his meetings in Washington, showing that an ease in the IMF programme’s conditions, despite the floods, is not a given (IMF review due in November). Mr. Dar has also dropped the plan to approach the Paris Club for debt restructuring, possibly because it may have entailed taking a haircut on commercial debt as well. With both Moody’s and Fitch downgrading Pakistan’s credit rating by a notch to Caa1 and CCC+, respectively, the government has doubled down on its efforts to win bilateral debt rollover and fresh investments - Prime Minister Sharif is set to be in China on November 1-2, having met the Saudi Crown Prince last week. Success on this front can ease Balance of Payment concerns, reduce PKR volatility, and help build the case for earlier-than-anticipated interest rate cuts. If this plays out, we believe the market may look beyond politics and commence rerating. Our base-case remains the full repayment of maturing international sukuks in December.  

The KSE100 has held up this year

Despite the intense political and economic pressure this year, the KSE100 is down a muted 7.5%CYTD, much lower than global equities, where we believe the cheap valuations already incorporate the risks. In US$ terms, equities are down to sharper c 26%CYTD, but currency weakness against the US$ is global and not specific to Pakistan. Our assessment of a favorable risk-reward is backed by strong corporate profits, up 25%YoY for the IMS Universe in 3QCY22, led by Banks, Oil Exploration and Technology. We keep top picks unchanged (see overleaf). The table on page 3 can be used to identify other cheap stocks that can deliver outsized returns on valuation mean reversion.