OPEC an impotent entity

OPEC, which pumps about 40 percent of the world’s oil, is scheduled to meet in Vienna on 2nd June to assess its output policy. The group is unlikely to set a production target as it sticks with Saudi Arabia’s strategy of squeezing out rivals such as higher-cost shale drillers.

Gone are the days when OPEC, led by Saudi Arabia enjoyed power to control oil price. Now it is desperately trying to retain its market share by pumping as much oil as possible. It has fallen in the trap of United States, which pampered the kingdom to raise oil price to facilitate shale oil production.

After having achieved the status of largest oil producing country, the US no longer to handhold Saudis, in fact by lifting sanctions imposed on Iran, Saudis feel the real pinch. They know Iran is adamant at attaining its pre-sanctions output. Saudi’s suffering from myopia are unable to read writing on the wall.

There can’t be any doubt that surge in supply of shale oil has reduced Saudi ability to balance crude markets. To be honest Saudis just can’t play any balancing role because of fear of loss of market share. In the past OPEC’s practice was to vary output to manage crude prices.

Market forces are too strong now, and you can’t play against those. Crude has surged more than 80 percent from a 12-year low earlier this year on signs the global oversupply will ease amid declining output in Nigeria and non-OPEC countries including the U.S.

Experts estimate current global inventories at about 5 billion barrels oil, including crude in floating storage, and say the market is oversupplied by about 1.5 million barrels a day. Just to cut production by 1.5 million barrels a day and the next day the price goes up and the other producers will take the whole share -- there is no benefit for OPEC in that.

High oil prices in recent years were an incentive for many high-cost fields to be tapped. If shale oil companies were to collapse due to financial strain imposed by low prices, this might cause another crisis like the one in 2007 and 2008, as many of them owe large debts to banks.

Pakistan stock market closes the week almost flat

The benchmark of Pakistan Stock Exchange PSX‐100 Index closed flat for the week ended 27^th May at 36,694. The index returns underperformed the region by 2.40% due to heavy‐weight sector banking’ disappointing run amidst unexpected 25bps cut in policy rate by the State Bank of Pakistan (SBP). This also caused average daily traded volumes to plunge by 23%WoW to 249 million shares as compared to 325 million shares exchanging hands a week ago.

Though, foreign selling continued, it stood at US$3.81 million as compared to US$6.98 million a week ago. Leaders during the outgoing week included: HASCOL, PSMC, DAWH, SNGPL and ENGRO, while laggards included: MCB, MEBL, EPCL, HBL and SSGC.

Key developments during the week included: 1) MCB said to be in preliminary non‐binding discussion with Fullerton Financial Holdings for a possible merger with NIB, 2) GoP decided to increase PSDP outlay by 11% for FY17 to Rs1.675 trillion from current year’s allocation of Rs1.514 trillion, 3) GoP likely to increase the tax on dividend income to 20% for non‐filers while 15% tax on dividend income for return filers and it may also start charging advance tax on the alternate corporate tax, 4) SBP slashed the policy interest rate by 25bps to 5.75% in view of its assessment that inflation would remain below the target set for the FY16 and 5) the current subsidy on DAP to the tune of Rs20 billion (Rs500/bag) shared on a 50‐50 basis by the federal and provincial governments is likely to continue in the next fiscal year with Ministry of Food proposing to remove the GST on DAP and other fertilizers.

Anticipations about next fiscal year’s budget, due to be presented next week, continue to build up and will keep the index range bound. Analysts expect the budget to remain neutral for most sectors, with chances for some negativity in foods and other import‐based sectors, amidst proposals for customs duty hikes. Additionally, increased spending on infrastructure, farmer subsidies (proposal to remove GIDC, continuation of DAP subsidy) and provincial schemes would keep cements, fertilizers and steel sectors in lime light. However, with Ramadan around the corner, the theme of lackluster volumes and listless trading is expected to prevail.

I posted a blog ‘too little too late’ after SBP announced 25 basis points reduction in interest rate. However, Pakistan leading brokerage house AKD Securities has a different stance. In its report it has said that contrary to market's consensus of interest rates having bottomed out, the SBP in its latest announcement cut the policy rate by 25bps to 5.75% (DR: 6.25%). The surprise move came with little justifications where the statement highlighted: 1) higher inflation projections for FY17 on expectations of global commodity price recovery and higher domestic tariff and tax incidence, 2) limited credit uptick (8.4%YoY as of Mar'16) despite prior 400bps rate cut, 3) BoP risks in the form of higher trade deficit, decelerating remittance growth and weak capital inflows ‐ all key macro trends warranting a prudent stance. With tighter fiscal targets, the 25bps reduction is unlikely to serve as a growth catalyst, where analysts view GoP to emerge as the key beneficiary with nearly Rs1.6 trillion PIB maturities due July'16. With macro risks in place, a quick reversal in the monetary policy remains a possibility, though key determining factors from here onwards are likely to SBP's target for real interest rates and PIB roll‐over.

With Budget FY17 less than two weeks away, market expectations regarding are running high. Targeting GDP growth rate of 6.2% (4.71% in FY16), news flow is shaping budget FY17 to be unpopular in nature, where additional taxes will be imposed, to boost up FBR related up revenues, are already under consideration. In this regard, super tax extension, withdrawal of remaining SROs, increase in Withholding tax on banking transactions to 0.6% for non‐filers, are some of the important ones. While continuation of Super Tax undermines profitability growth of the  bluechip companies, positives for Fertilizer is removal of GST/GIDC on urea, subsidy extension on DAP to aid offtake growth) and Autos (lowering of import duties in order to incentivize incumbents) whereas negativity could come in Foods Producers (imposition of 10% sales tax on milk). That said, market level developments (such as increased taxation on dividend income, removal of tax exemption on pension funds) are not very encouraging either. While initial market reaction could depict volatility, investors' sentiment and attention are most likely to soon turn towards the MSCI reclassification (EM status) announcement on 14th June.

Pakistan reduces interest rate by 25 basis points

On 21st May 2016 State Bank of Pakistan (SBP) issued Monetary Policy Statement for next two months. It has attracted mixed reaction, some term it too little and too late, while many term it a surprising move. However, a few term it an anticipated move and the evidence was rejection of all the bids received in the recent auction of Pakistan Investment Bonds (PIBs).

Many of the financial sector experts were under the impression that in May the SBP would increase the policy rate. This mindset was evident in PIB auction and SBP stance demonstrated though rejection of all the bids. However, one completely fails to understand the logic behind 25 basis point reduction. If the PML-N government is serious in boosting GDP growth rate, it has to reduce the policy rate minimum by 100 basis points.     

It is pertinent to note that SBP last cut the rates by 50bps in September 2015 and since then it has been maintaining status quo in subsequent announcement. SBP forecasts headline inflation (CPI) to remain within targets for the CY16 and going into CY17 to gain upward momentum. However, missed GDP growth target of 5.5% remained major concern and rate cut is expected to help spur growth.

Even though the inflation has been on the rise for past 7 months, SBP expected the outlook to remain low for CY16. However, with rising oil and commodities prices and expected imposition of certain tax measures by the Government in upcoming budget the SBP forecast the inflation to gain upward momentum in CY17. 

Large Scale manufacturing (LSM), mainly supported by construction and consumer durables, automobiles, fertilizers, and cement production, grew 4.7% in the July-March CY16 compared to 2.8% a year ago. The growth is expected to gain further on the back of improved electricity and security situation, according to SBP.

SBP also noted stability in balance of payments and upward trajectory in foreign exchange reserves on account of healthy workers’ remittances and lower international oil prices to keep the situation within manageable levels. Furthermore, SBP remained optimistic on external front, likely on account of continued workers’ remittances and bilateral inflows owing to various projects under CPEC.

Equity markets in general would perceive 25bps cut optimistic as it inflates the valuation especially for highly leveraged companies and sectors. Analysts maintain their likeness for cement, fertilizer, textile and other manufacturing base sectors which would remain in limelight going forward. Margins for banking sector are likely to shrink further thus putting banks under pressure. However, their profitability is likely to remain intact due to revaluation gains in PIB's portfolio.

Some market analysts see room for further reduction of rates, to spur growth. However, many expect SBP to keep rates on hold in near future, owing to rising inflation. A marginal upward move in inflation figures in upcoming months would be in line with SBP estimates. However if those numbers inflate somehow, SBP will have to revisit its rates policy sooner than later.

Pakistan stock market benchmark index up 7 percent in last 15 days

The market continued to build on last week’s rally with the PSX‐100 gaining 1.58%WoW to close at its record high of 36,694 points amid anticipations of reclassification to EM status in MSCI’s annual review next month and global crude venturing near the US$50/bbl mark.

Activity at the bourse witnessed a sharp uptick during the week with daily average trading volume growing to 325.4 million shares up 10.5%WoW. Foreign participation, however remained negative (net basis) with outflows for the week recorded at US$6.98 million, albeit lower than US$12.71 million last week.

Key news flows relating to the broader market were: 1) SBP scheduling release of monetary policy statement on  21^st May (Saturday), 2) GoP rejecting bids in the latest PIB auction as participants bid at significantly higher yields, 3) LSM growth registering at 4.7%YoY for 9MFY16 with Automobiles (+23.43%YoY) and Fertilizers (15.92%YoY) leading the growth, 4) fiscal deficit for 9MFY16 was reported at 3.4% per cent of GDP, and 5) PSO announcing plans to build a refinery valued at US$6 billion to expand into processing crude.

Expected GoP’s revenue generation measures for Budget FY17 including: 1) enhancement of FED on beverages and cigarettes, 2) imposition of 10% sales tax on branded milk and 3) increase in tax to 17% for other dairy products and levying of sales tax on all types of meat sold in retail packing, animal feed and seeds used to produce cooking oil.

Scrips leading the bourse were: PPL, MCB, KEL, PTC and HASCOL, while laggards included: NBP, HMB, BAFL, INDU and ASTL.

While political concerns can emerge as PML‐N and opposition continues to lock heads over Panama leaks, the market is likely to remain resilient with short‐term investor interest likely to be guided by the upcoming budget and the outcome of the MSCI EM reclassification review on 14^th June this year. On the global front, commodity price movements can propel performance in related sectors.

With the benchmark index up 7% in last 15 days, you are probably not alone in thinking being caught by surprise. While this performance should be termed no less than stunning, the benchmark is currently touching its highest level. In the backdrop of a looming MSCI decision regarding Pakistan's reclassification as an Emerging Market (EM), market sentiments have shifted from outright confusion (hurried regulatory actions against 'non‐compliant' entities/individuals and political uncertainty) to premature jubilation (anticipation of MSCI's decision in favor of Pakistan). Despite risks, the possibility of EM reclassification along with joint efforts by SECP, NCCPL and PSX to address shortcomings in the system and improve liquidity all together form the perfect catalysts to drive the index towards 37,400 levels at least in the short term.

More recently, the market has also shown a tendency of heating up. However, possible EM reclassification along with stable macros and materialization of energy and infrastructure projects under CPEC should narrow the current discount of 28% of the PSX-100 against the MSCI AP excluding Japan.