Pakistan stock market coming out of Brexit syndrome

As the fears of Brexit started easing benchmark of Pakistan Stock Exchange, PSX‐100 Index managed to close at 37,784 for the week ended on Thursday. Friday was a holiday on account of last Friday of Holy month of Ramadan.

Foreign selling also continued, though with much lesser magnitude reported at US$3.61 million during the week as compared to US$20.56 million a week ago. Ramadan factor eclipsed MSCI EM upgrade as the benchmark index barely crossed pre‐MSCI level of 37,518.

Average daily traded volumes fell by 8%WoW to 143 million shares as compared 155 million share due to trading curtailed to four day. Leaders during the week under review included FATIMA, HCAR, DAWH, AICL and ABL, while laggards included MTL, NML, AGTL, FFC and FFBL.

Key developments during the week included: 1) Ogra recommending an upward revision in per liter prices of HSD by Rs3.75 to Rs79.27 and motor gasoline petrol by Rs1.93 to Rs66.20, despite crude oil prices easing in the international markets, 2) ADB approving a US$600 million loan to help Pakistan roll out major structural reforms to improve the performance and financial sustainability of its PSEs, 3) the book‐building process for the IPO of TPL Properties has raised Rs696.8 million at the strike price of Rs12.50/share, 4) LSM posting a growth of 3.92%YoY in the 10MFY16 reflecting a partial revival in the industrial output, and 5) KEL submitting a Multi‐Year Tariff petition with Nepra seeking an increase in tariff by Rs0.66/unit in the name of O&M component for ten years commencing from July 1, 2016 to June 30, 2026 and has also sought a change in claw‐back formula threshold.

Though Brexit fears eased in the outgoing week, volatility is expected to remain relatively higher due to unfolding developments in the process. Nonetheless, re‐rating associated with the MSCI EM upgrade will likely provide impetus to the Index. Additionally, the end of Ramadan will mark return of volumes out of dormancy to normal levels. Keeping in view marker dynamics analysts recommend taking new positions in main blue chips that will likely make way into MSCI EM list that OGDC, HBL, MCB, UBL, LUCK, ENGRO, FFC, HUBC and PSO.

Latest banking sector data released by State Bank of Pakistan for May'16 indicates that banks' balance sheet continued to grow at strong levels, up 19%YoY, to Rs12.1 trillion. While private sector credit growth has not been substantial on account of bank's continued preference for risk‐free government securities (banks' lending to government grew by more than 29%YoY in May'16, posting growth of 8.2%YoY in May'16 alone. However, consumer financing grew by 9.3%YoY to 7.7% of the private sector loans as banks look to re‐focus on high margin auto finance and personal loans in the current lower inflationary environment. Spreads are likely to bottom out on possible monetary tightening in CY17. Analysts retain our liking for banks that offer: 1) superior ROE profile, 2) keen focus on growing low cost current accounts, 3) diversified income streams and 4) ability and reach to capture CPEC related investments.

Brexit keeps Pakistan market under pressure

To begin with, it may be true that the local equity market remained under pressure due to Brexit, which was an overreaction. The decision by the public is yet to be approved by the British parliament. It will be a long drawn process but meantime the business will continue ‘as usual’.

The panic trickling down to Pakistan Stock Exchange plunged the benchmark PSX-100 index to 37,390 levels, down 3.58%WoW, after losing 1,412 points intraday. Regional markets also witnessed similar trend while crude oil tumbled, along with other commodities on a stronger dollar.

Barring Friday, lack of triggers kept market activity dull during the week where average daily volumes declined by more than 15%WoW to 155.7 million shares. Foreign participation remained under pressure, with foreigners selling equities worth US$20.6 million during the week against a net buy of US$19.58 million last week.

Key news flow impacting the market included: 1) National Assembly finalizing amendment in 2016 Finance Bill, 2) Current Account deficit for May’16 rising US$792 million as against a surplus of US$23 million a month ago, 3) the World Bank approving US$1.02 billion in developmental loans for Pakistan under the CGDPF and Sindh Resilience Project, while ADB approved US$100 million loan for the construction of Shorkot‐Khanewal section of the M4 motorway, 4) yields slipping by 3‐ 5bps in the latest Market Treasury Bills auction with the GoP raising Rs138 billion and 5) news source indicating rise in petroleum prices in the range of Rs1.75‐Rs4.5/ltr for July’16. Leaders at the bourse were: MTL, FATIMA, HMB, FCCL and AGTL; while laggards included: BAFL, MCB, AICL, NML and NCL. Volumes leaders were: KEL, DCL, PAEL and DFML.

Bouts of volatility are likely to be witnessed in the week ahead as investors react to uncertainty in the global outlook following ‘Brexit’. Negative implication for the bourse can also emanate from any extended downside in commodities, particularly crude oil. With volatility in major currencies, Autos on (JPY) and Textiles (on EUR and GBP) could see further downside.

After recording surplus for three consecutive months, current account balance returned to the red zone in May'16 recording a deficit of US$792 million expanding, consequently, 11MFY16 current account deficit to US$2.48 billion, up 1.2%YoY higher than the balance in 11MFY15, primarily reflecting a worsening trade deficit. The trade data depicts 22.6%YoY widening in the trade deficit in May'16 as rising imports (up 7.6%YoY) added to the burden of declining exports (down 6%YoY). With similar trends to continue analysts expect current account deficit to further deteriorate. Resulting pressures on current account and hefty debt repayment in FY17 can likely have spillover effects on the Pak rupee exchange parity. However, rising foreign exchange reserves and improving foreign investment outlook should keep erosion in rupee value limited.

Does Brexit mean anything to Pakistan?

As part of my daily chores, I read a lot of content pertaining to commodities, currencies and stock markets. I often wonder if this flood of information makes decision making by Pakistani investors easier or force them to make investment decisions that ultimately become loss yielding for most of them.

At present a lot of being talked about Britain’s exit from the European Union (Brexit). Whatever may be the outcome of the referendum scheduled for 23^rd June, it will be of little consequence for Pakistan. This may sound a sweeping statement but if one keeps various factors in mind affecting trade between the two countries, understanding the likely implications will become much easier.

Britain may be a major buyer of ‘Made in Pakistan’ products but most of the trade is USD denominated. Therefore,the involvement of three currencies i.e. GBP, EUR and USD often nullify the benefit emerging from the movement of one or more than one currencies.

Most of the investors prefer to convert their saving into USD, which they consider more trustworthy, simply because PKR value depreciates regularly. Many of the exporters try to without their payments outside Pakistan in anticipation of erosion in PKR value.

Movement of international gold price is also of little consequence. Pakistan consumes around 250 tons of precious metal per annum. Out of this, 50 percent demand is met through ‘recycling’ and remaining quantity is ‘smuggled’ into the country. Official import is around half a ton for 10 months of the current financial year. On top of this price in the local bullion market is driven by domestic demand rather than international price.

There are two global benchmarks of oil, Brent and WTI, these carry hardly any relevance for Pakistan because the country buys ‘Middle East Crude’ where price is driven by ‘geopolitical’ considerations rather than prevailing international prices of Brent and WTI.

There is also a lot of hype about Pakistan’s inclusion in MSCI Emerging Markets and the overall perception is that up to USD1.5 trillion can make inroads into Pakistan. The statement sounds highly exaggerated keeping in view the inflow/outflow of foreign funds. Overseas investors already hold 30 percent shares of the blue-chip companies. According to some estimates, often monthly outflow comprising of dividend/capital gains exceeds inflow. Therefore, one of the possible fallouts could be outflow surpassing inflow.

Last but not least the hype about the US Fed increasing interest rate sounds like ‘exchange rate maneuvering’. On one or the other pretext the Fed has been deferring interest rate hike for more than a decade and hoping any hike in near future is hoping against hopes.

Pakistani’s should pay more attention to factors affecting its economy and ruling junta should try to remove the impediments affect GDP growth and exports rather than introducing news tax measures. It has been reported in media that the incumbent government has already exceeded its expenditures by more than PKR250 billion against the target, exports have nosedived and there is a visible deceleration in remittances. Many experts warn that debt servicing has become unsustainable and the government is borrowing more and more to pay off the debts.

Pakistan reclassified in MSCI Emerging Market

MSCI has announced to reclassify Pakistan in the MSCI Emerging Market Index in its Annual Classification Review, with a proforma weight of 0.19% (amongst the lowest in the EM group). Pakistan’s leading brokerage house, AKD Securities estimates gross passive inflows of US$500 million upon formal inclusion.

While benefits to derive are numerous, increased foreign visibility and participation particularly amid continuous foreign selling (CYTD net FIPI outflow of US$36.4 million) along with potential multiple re-rating (PSX-100 index traded at an average P/E multiple of 10.2x over 2006-08) are likely to be the most profound.

Despite rallying by 8% since May'16 in anticipation of a favorable decision, brokerage house believes the reclassification announcement is likely to make room for a further continuation of the recent bullish momentum with select stocks (included in the MSCI EM index) leading from the front. PSX-100 Index can statistically gain 15 to 20 percent surpassing 43,000 level over the next 12 months.

It is widely quoted that up to US$1.6 trillion is benchmarked to the MSCI EM Index (including both active and passive). A proforma weight of 0.19% should result in Pakistan attracting at least US$3 billion in both active and passive flows. Assuming passive investment constitutes 15 to 20 percent of overall funds benchmarked to the MSCI EM Index, roughly US$500 million in gross passive inflows into Pakistan can be expected upon formal inclusion.

While Pakistan is now set to compete with EM economies, brokerage house remains optimistic on Pakistan's attractiveness in the index backed by a promising macro environment. Favorable macro trends (decade low inflation and interest rates coupled with external stability) support Pakistan's economic growth trajectory. Major growth themes are 1) spurring industrial activity and consumer demand, 2) investment in infrastructural development and energy generation, likely boost GDP growth above 5 percent over the medium term. With positive implications for corporate profitability, strong consumer demand and development initiatives are now reflecting into a robust topline of Cements, Paints, Glass, Automobiles and Food Producers (excluding sugar).

Wary of continuous selling pressure, brokerage house sees Pakistan's reclassification into the MSCI EM index as a key confidence booster for the market. However, the latent risks exist in the form of: 1) political, both domestic and foreign policy related and 2) Brexit can cause turbulence due to heightened risk aversion of global investors.