Pakistan must address structural issues on top priority

Historically Pakistan and International Monetary Fund (IMF) has lived with each other, at times with comfort and at tome with some unease. While the IMF role as ‘lender of last resort’ has helped Pakistan in overcoming economic malice, the loan covenants are often seen by Pakistani’s rather stringent.

Ideally the ruling regime in Pakistan should be more careful in formulation of policies and implementing these in letter and spirit but the overall impression is that the successive governments sooner or later suffer from complacency. It may also be said that political agenda pushes economic agenda in the back ground. Many analysts strongly believe that condoning deviation may not be difficult had appropriate efforts were made. In other words these deviations are the result of not following the ‘IMF Recipe’.

A team of AKD Securities, Pakistan’s leading brokerage house, recently met the IMF Regional Representative for a discussion on Pakistan’s progress on the macro front in the context of the ongoing EFF program. After the meeting it has also released a report that has many takeaways.

While progress on reform agenda so far remains commendable, continued reform implementation post completion of the program was stressed, where energy crisis and low revenue collection continue to rank as high priority issue areas.

The IMF, though cognizant of likely delays, sees room for steady structural changes even post completion of the program based on higher GoP resolve. Benefits of low oil prices and earlier reforms have placed Pakistan in a macro sweet spot with economic indicators marking record levels.

Agreeing with the IMF, AKD team believes this opens room for addressing deeper structural issues that can help Pakistan sustain recent economic gains where key reform areas highlighted were: 1) exports sector revival, 2) tax base expansion and 3) efficient expenditure and resource allocation between federal and provincial governments.      

Key takeaways

Priority on energy and revenue: Key issue areas for reforms that retain the highest priority were Energy and Revenues expansion – both resonated by all participants. Resolution to the country’s energy problems was highlighted, particularly in the context of its impact on industrial growth. Also, revenue collection remains equally crucial where considerable focus should be directed towards structural changes both through a) regulatory/legislative action and b) operational changes in FBR/tax collection mechanisms.

Privatization to slowdown: The privatization program remains on agenda, however it is likely to stretch beyond the current program as political opposition in PIA’s strategic divestment and labor union concerns in case of DISCOs continue to be major hurdles. That said, recent road shows for DISCOs’ sell-off were regarded as a key positive. Analysts expect revision of current timeline in the upcoming IMF review report for December 2015. Moreover, with the current government resorting to populist decisions in the run up to next general elections (expected 2018), the brokerage house highlight heightened risks to PSE sell-offs.

Another program unlikely: With the current program effectively concluding in June 2016, rollover to another program remains unlikely on account of Pakistan’s stable Balance of Position position. However the Fund is likely to remain engaged in a consultative process with the GoP to monitor current program objectives, though without imposition of conditions/targets.

CPEC – lack of clarity lingers: The Fund views the landmark China Pakistan Economic Corridor (CPEC) agreement as largely positive, though details on nature of agreements remain sketchy and are yet to be factored in fiscal expectations/targets. Alongside, infrastructure projects need for investment in export oriented sectors was also noted. 

Putian has all the reasons to visit Pakistan

Reportedly Russian Ambassador, Alexey Dedov said there was no reason the Russian President should visit Pakistan. His statement not only sounds amateurish but also shows his lack of understanding of the geopolitical scenario of the region. It may be an irony that the Russian diplomat is not only unaware of the history but also lack vision.

While delivering a lecture on Pak-Russia relations at the Institute of Strategic Studies, Islamabad he said, “The problem is that usually the purpose of the visit is not participation in ceremonies. The visit should have some substance.”

Ambassador Dedov defined the substance as “signing of documents” for cooperation, “preparation of plans” for expanding ties, and “declarations”.

The point to ponder is that no Russian or even Soviet president has ever visited Pakistan. President Putin had planned a visit to Islamabad in October 2012 for attending a quadrilateral summit between Pakistan, Russia, Tajikistan and Afghanistan, but cancelled it at the eleventh hour.

Former USSR and now Russia had a grudge that Pakistan remained in the lap of United States and also fought a proxy war in Afghanistan for a decade but have they ever bothered to review their own attitude? India, arch rival of Pakistan has always remained a darling of USSR/Russia.

The situation changed a bit during the regime of Prime Minister Zulfikar Ali Bhutto, only because of a bad patch of Pak-US relationship. This was because many Pakistanis strongly believed that the US played a key role in the creation of Bangladesh.

I would even go to the extent of saying that at that time USSR failed in exploiting the situation. It may also be said that assault on Afghanistan was considered a serious threat for Pakistan. That is the reason when USSR attacked Afghanistan, the US once again convinced Pakistan to fight its proxy war.

It is also on record that China, despite being a communist country, succeeded in maintaining the most cordial relationship with Pakistan. China was also fully aware of the US influence on Pakistan but never dragged it in Indo-China conflict.

The latest evidence of Pak-China strong relationship is agreement on development of China Pakistan Economic Corridor (CPEC), as against this Russia has not focused on developing economic relationship with Pakistan.

Russia played a major role in convincing the west to stop proxy war in Syria. If Russia is serious in expanding its influence in the region, it has to play a role in resolving Kashmir issue that has led to three wars between India and Pakistan.

Pakistan equity market driven by rising oil prices

During week ended 18th March benchmark PSX-100 Index gained 411 points or 1.126%WoW to close at 33,080 points. The rally was driven by two factors: 1) corporate restructurings (divestments in EFOODS, EFERT, and acquisition of NIB) and 2) crude oil prices registering upward move. Material disclosures of corporate actions by ENGRO were received positively by investors. Foreign participation failed to sustain the trend (US$4.1 million inflows) witness a week ago where net outflows during the week amounted to US$7.6 million.

Key news flows for the week were: 1) US Fed maintained interest rate policy, while expressing concerns about global economic outlook adopting a dovish stance on future rate hikes, spurring performance in emerging market equities, 2) GLAXO announced details of its Sindh High Court approved divestment of its Consumer Health Care operations, with investors getting 10 shares for every 3 shares held in the parent entity, 3) HTL expressed its intention to apply for an OMC license from OGRA expanding into the retail fuels segment, 4) Auto Policy dominated news reports with conflicting details regarding greater incentives for domestic assemblers and, 5) National Assembly passed the Futures Market Bill, 2015 and Financial Institutions (Recovery of Finances) (Amendment) Bill, 2015 in a bid to promote investment avenues and facilitate recovery of bank loans.

Stocks exhibiting strong performance during the week included PPL, INDU, UBL and 4) KEL; conversely laggards were BAFL, HMB, MEBL and HCAR. Average daily turnover was down by a mild 4.76%WoW closing at 166.8 million shares. The volume leaders were NIB, KEL, BOP and TRG.

Approval of the Auto Policy (which has experienced its fair share of delays) may spur performance if planned incentives to current players are enacted. Strengthening commodity prices boosted largely by weakness in the US$ (Dollar Index down 1.8%WoW) are expected to follow through in the coming week. The central bank is scheduled to issue Monetary Policy Statement next week where a further easing remains unlikely.

Despite tapering input costs improving liquidity, burdensome overdue receivables in the power sector continue to plague HUBC's balance sheet, signified by: 1) Rs66.9 billion in overdue receivables from WAPDA & NTDC, down 18.6%YoY but up 6.4%QoQ, 2) increased reliance on short term borrowing where a 46.4%YoY and 57.3%QoQ jump in short term borrowing was witnessed during 1HFY16 and 3) decline in receivables failing to keep pace with declining revenues, raising Days Receivables to 271 days vs. 211 days for the corresponding period last year. On the other hand, a slide in payables (overdue payables to PSO recede 26.5%YoY, rising 6.8%QoQ) has improved the current ratio slightly. That said, income from Laraib and PCE + Bonus payments from the base plant continuing to drive payouts (making up Rs4.24/share of the Rs4.5/share payout declared in 1HFY15). Upcoming payments for new ventures include outlays for 660x2MW coal fired expansion and acquisition of 9.6% stake in SECMC, and a two month time period provisioned between receipt of term sheet from lenders and declaration of financial closure, analysts expect initiation of equity outflows worth Rs5.87 billion (at 49% equity stake on 80:20 leverage) from 1QFY17.

Pakistan stock market closes week flat

The PSX‐100 index snapped its ten‐day winning streak during middle of the week ended 11^th March 2016 and closed at 32,669 levels, up 0.70%WoW. Overall, activity at the market showed sharp recovery, where average traded volumes for the week ascended to 175 million shares as compared to 135 million shares a week ago.

Key news flows guiding the market included: 1) ECC of the Cabinet approved increase in withholding tax on banking transactions for non‐filers to 0.4% from 0.3% and deferred the approval of Auto Policy for more consultation, 2) NTC rejected petition of PSM for imposition of antidumping duty on import of iron ore and steel products from China, 3) National Assembly Standing Committee on National Food Security and Research recommended 60% excise duty on the import of dry milk to promote local dairy sector compared to the current rate of 30 percent, 4) MoF and the MoPNR gave the go‐ahead the Ministry of National Food Security and Research to frame policy allowing urea import by the private sector, while the NA Standing Committee on Industries and Production also directed NFML to import urea in order to curb domestic prices, 5) ISL inaugurated its capacity expansion of over 500,000MT of which 400,000MT can be galvanized at its state‐of‐the‐art steel complex in Karachi and 6) DPC approved around 12 applications envisaging an increase of up to 8% in the prices of the drugs concerned and deferred the issue of reduction in prices of innovator drugs.

Scrips that led the bourse included PTC, EFOODS, FFBL, PPL and AICL, while laggards were PSMC, HBL, UBL, APL and AKBL. Foreign participation witnessed marked improvement this week, where net foreign inflows for the week amounted to US$4.1 million as compared to net selling of US$1.6 million in the week before.

The market is expected to see consolidation around current levels where volatility can emerge from uncertainty in global oil price movements and regional flow trends. Upcoming key events include monetary policy review later this month, where State Bank of Pakistan is likely to maintain status quo due to expectations of higher inflation. This would bode well for banking sector which can gain traction as a 50bps hike in rate in September ’16 is being talked about. Data pertaining to US oil inventories and the possibility of an OPEC meeting may keep oil prices on upward trajectory, flowing through to the domestic Oil & Gas sector. However, many analysts remain skeptical about any consensus due to Iran’s likely agreement to freeze production at January’16 levels.

Despite a number of challenges faced during CY15, UBL was able to post decent earnings growth of 11%, with profit growth being a function of strong NII growth (+23%YoY) and capital gains utilization (+57%YoY). Going forward, analysts expect earnings growth to slow down to 4%YoY during CY16 where: 1) upcoming PIB maturities and lower banking spreads are making way for tighter NIMs and 2) continued risk of further deterioration in international book in the light of the global commodity slump will be key factors to be kept in mind. That said, UBL's sheer strength in terms of diversification of income streams (non‐core income makes 31% of total income), ability to grow loan book (already mandated for infrastructure projects) and sizable capital gains backlog are likely to provide support to earnings. UBL remains the most attractively priced scrips within the banking sector considering its size and superior ROE profile. Price performance however remains hinged upon the reversal of interest rate cycle that is likely to rejuvenate interest in the sector.

According to the latest dispatches data, cement demand has started to pick up where dispatches grew to record levels during February'16 as compared to a month ago. Pick up in domestic construction activity and respite in exports slump were the key highlights. As a result, cumulative growth rate of dispatches improved to 7.7%YoY during 8MFY16 from 6.4%YoY growth during 7MFY16. Companies outperforming the industry during the month included FECTC, FCCL, KOHC, PIOC, DGKC, and MLCF, while LUCK and ACPL remained underperformers due to continued fall in exports. On cumulative basis, KOHC, PIOC and FCCL continued to outpace the industry while LUCK and ACPL continued to face problems on account of failure to divert lost exports (South Africa/Iraq) to other markets. Domestic demand is expected to continue to grow at a fast pace at least during the remainder of current fiscal year on account of record level growth in PDSP spending and construction related private sector credit. Expected normalization of exports from FY17 and initiation of construction work on CPEC projects may further surprise with double digit growth rate in the medium term. Due to strong fundamentals, analysts continue to maintain an Overweight stance on the sector where their top picks include LUCK and DGKC on account of expansion to catch up with anticipated rising domestic demand.

Automotive sales during February ’16 declined to 15,873 units, whereas production figures mimicked this trend. Cumulative 8MFY16 sales/offtake moved by 121,934/121,735units, while 2MCY16 figures showed signs of exhaustion when compared to last year's exorbitant rise in sales/production for 2MCY15 as compared to 2MCY14). All OEMs witnessed monthly sales growth stalling, which may be due to the fading out of 'new registration' effect, while only INDU showcased growth. The 1000cc segment fared better than others in declining offtake, while all other segments posted declines, following the phasing out of the Punjab Rozgar Scheme (news reports indicate final deliveries were due in February’16). At current levels analysts express preference for INDU, citing resilience of Corolla sales (now in its 18th production month) and ability to pass on costs.

Why pressure on Iran to freeze oil production at current level?

Saudi Arabia and Russia initiated the move to freeze output at January 2016 level and other smaller oil producing countries joined them. However, most of the stories published by the western media regarding containing glut seems to be terming Iran as spoiler. One has to review the situation dispassionately to find if Saudi Arabia and Russia are being judicious in asking Iran to agree with their demand?
To begin with, it seems very interesting that the US that attained the status of one of the largest producers of oil lately is keeping mum. It may be because in the US number of active rigs have come down from more than 1,900 to less than 400 but the level of oil production has not come down correspondingly.
In my view the indifferent attitude of the US is because: 1) it managed to install record number of rigs and those suspending production can be brought online as and when desired, 2) the decline in oil price has caused enough damage to its arch rivals i.e. Saudi Arabia, Russia and Iran, 3) massive reduction in oil price has failed in accelerating GDP growth rate, even in the US and 4) on the contrary central banks of developed countries are forced to keep interest low and offer other stimulus for accelerating economic activities.
I also believe that Saudi Arabia is not ready to curtail its output because its economy is heavily dependent on oil. As against this Iran has endured sanctions because of its substantial non-oil exports. The other reason Saudi Arabia appears adamant at keeping Iranian oil exports low is the fear that after the withdrawal of sanctions and release of withheld payments, Iran can attain the status of regional super power.
Another point worth probing is why Russia, fighting a proxy war with Saudi Arabia in Syria, has joined hands with its arch rival? It may be said that Russia is trying to get its hold in the Middle East more firmly. In the region there are two contenders trying to attain the status of regional super power, Iran and Saudi Arabia. Over the years Iran has been fighting its own as well as proxy wars, whereas Saudi Arabia is militarily not strong enough, it has survived mainly with the support of US.
Russia also realizes that after the withdrawal of sanctions imposed on Iran, Saudi-US relationship have become strangulated. One can recollect that in the past Saudi Arabia relied on the US/Nato forces but lately it was forced to form a group of 34 countries to defend its interest. At present joint exercises are being held in Saudi Arabia that is a clear message to the US that Arab Monarchs have found the alternative.
In the prevailing situation Saudi Arabia wants to maximize pressure on Iran by keeping its oil exports at the lowest level. However, the logic being followed by Saudi Arabia seems to carry no weight as all the countries have snatched Iran’s share. If Iran is demanding up to 4 million barrel per day production it is fully justified.

OGDC assigned Triple AAA rating

Pakistan’s largest exploration and production entity, Oil and Gas Development Company Limited (OGDC) has been assigned a long-term entity rating of 'AAA' (Triple AAA) and short-term rating of 'A1+' (A One Plus) by Pakistan Credit Rating Agency (PACRA)

These are the highest ratings on respective entity ratings scale and denote the lowest expectation of credit risk emanating from an exceptionally strong capacity for timely payment of financial commitments.

The ratings reflect OGDC's strategic importance to the government of Pakistan for being the largest upstream oil and gas company having predominant share of recoverable hydrocarbons reserves and exploration acreage.

Moreover, the company is the leading contributor in the country's major hydrocarbon mix production and its oil and gas production continues to help the country in saving huge foreign exchange.