Macro Analysis /

Pakistan strategy: Well placed amid lower oil prices

  • Oil price collapse has the potential to speed up Pakistan’s economic recovery and market re-rating

  • The event alters inflation outlook materially, where we see a high probability of interest rate cut in the March MPS

  • Sharp cuts in estimates of our E&P coverage, but the event can prove positive for many cyclical sectors

Intermarket Securities
9 March 2020

International oil prices have fallen sharply, the most since the oil price collapse in 2014-15, triggered by a price war between Saudi Arabia and Russia and exacerbated by the coronavirus outbreak. Although prices have begun to rebound, it is possible that they remain relatively low in the near term. For net oil importers such as Pakistan, this can shape up to be a significant positive (petroleum imports are c5% of Pakistan’s GDP and contribute more than 20% of the import bill).

With the IMF programme back on track and significant room to catch up on global monetary easing, Pakistan’s equity market should do well through the cycle, in our view. We flag that interest rates are at a cyclical peak (the last rate cut took place in May 2016), valuations are near historical troughs (forward P/E: 7.0x) and corporate profitability (ex-oil) is expected to rebound from here. As this plays out, the KSE-100 is well placed to depict a multiyear rally.

Inflation and interest rates: Oil directly takes up c6% weight in the CPI basket. Assuming a 15% mom decline in petrol prices in March 2020 (fully passed on, all else the same), CPI can drop down to less than 10% (vs. base case of 10.8%). With inflation outlook shaping up to be more benign, we think the SBP will have more latitude to initiate interest rate cuts in the upcoming March monetary policy, particularly as interest rates have also come down globally. As a result, it is possible that cumulative interest rate cuts across 2020 could be potentially greater than our base case estimate of 100-125bps.

External a/c and PKR: The 7M FY 20 current account deficit is US$2.6bn (annualized CAD: 1.6% of GDP). Even if remittances come down from their current monthly run rate of US$1.9bn (c50% of remittances originate from the GCC), the reducing import bill should offset this, in our view. In this backdrop, it is surprising to see the PKR slipping by 1% today (it is now under a market determined regime), our outlook on PKR remains unchanged where we project average USD/PKR to settle at c161 for FY 21. Moreover, we flag that Pakistan may revisit its plans to launch up to US$3bn of Eurobonds, that have so far been put on hold partly due to sizeable hot money inflows into government securities.

There are positives for the fiscal deficit too – we expect lower oil prices to provide breathing space for the government, particularly ahead of pending gas and electricity tariff hikes (electricity rates for ex-WAPDA distribution companies have been frozen until June 2020). We also expect the government to partially utilise the benefit of lower oil prices to settle outstanding circular debt dues.