Pakistan inching towards balance of payment crisis

Remittances to Pakistan have been on a decline (down 3.8%YoY in 4MFY17), where recovery following the sharp dip in July16 (-20%YoY) has been slow to materialize.

 Driven by weak global macro dynamics and depressed crude oil prices the trend remains similar to other regional countries (Bangladesh/India down 9%/14%YoY in CY16TD) which are also considerably reliant on remittance flows.

 Going forward, we expect seasonal recovery to keep remittances marginally higher in FY17. With effects from current trends lingering we project remittance growth to remain in low single digits over the medium term.

 In this context, we highlight room for greater BoP volatility on weaker trade dynamics. Nonetheless, support to external account is expected to come in the form of higher foreign debt inflows (multilateral and bond issuances) driving exchange rate stability and consequently keeping depreciation pressures on the Pak Rupee limited.

 Pakistan emerged more vulnerable in the region due to a weak global macro outlook impacting remittance flow adversely, with major impact on South Asian countries that share reliance on remittances (avg. Remittance/GDP ratio: ~10%) for foreign inflows.

 Depressed crude prices affecting labor dynamics in GCC region has been a key driver in this regard where the region receives ~63% (2015 est.) of all GCC-sourced remittance. Consequently, Bangladesh and India have seen sharp decline in remittances with flows contracting 9%YoY and 14%YoY in CY16 so far respectively.

 Though initially sturdy, Pakistan is also witnessing a slowdown in remittances with 4MFY17 inflows declining by 3.8%YoY, where inflows from the GCC region declined 4.6%YoY in the same period.

 However, analysts take it as a bigger concern for Pakistan compared to regional peers in the backdrop of worsening trade dynamics (trade deficit up 11%YoY in FY16) compared to Bangladesh/India that contracted trade deficits by 9%YoY/10%YoY in FY16. With oil prices unlikely to mark a sharp recovery in the near-term and slow global demand recovery (UK/European economies), outlook for remittances remains tepid, where the WB has projected a dip of 2.3% in 2016, followed by moderate recovery in 2017/18 (2.2%/2.3% growth).

 Similar to the region, outlook for remittance to Pakistan remains subdued where analysts expect flows to stagnate around US$20 billion. Though currently on a decline, they see room for seasonal recovery near the end of FY17 - with flows increasing marginally for the year.

 Going forward, effects of low oil prices are likely to linger over the medium term, strong correlation of GCC remittance and oil price decline. On the other hand, recent dip inflows from US on account of higher transfer costs is expected to normalize.

 In aggregate, remittance growth is projected to remain in single digits over the medium term. However, key risks remain in the form of further slowdown from UK/EU region on account of Brexit and concerns emanating from recent US elections.

 Going forward, expanding trade deficit (FY17F: 14%YoY) amid weak remittance outlook remains a major risk to BoP stability, where analysts see current account deficit rising to 1.7% of GDP as against 1.2% for FY16).

 That said, concerns on exchange rate stability remain limited, where analysts derive comfort from expected foreign debt inflows (multilateral commitments and another bond issue planned) keeping foreign exchange reserves position stable.

This remains a key positive for exchange rate strength, where stronger foreign exchange reserves position will provide room to counter current account weakness.

Pakistan Stock Exchange closes at all time high

The benchmark index of Pakistan Stock Exchange (PSX) closed at an all‐time high of 42,849 points for the week ended 11^th November 2016. Average daily traded volumes inched up by 2%WoW to 494 million shares where volume rankings continued to be occupied by second tier scrips such as: BOP, PIAA, TRG, TELE and SSGC. Leaders during the outgoing week included: AGTL, MLCF, SSGC, FCCL and FFBL while laggards included: SHEL, KEL, HUBC, OGDC and NBP.

Key developments during the week included: 1) almost 22%YoY increase in trade deficit to US$9.32 billion during first four months of current financial year, 2) a 3.83%YoY decline in workers' remittances to US$6.26 billion, 3) increase in cutoff yields of Treasury Bills of 3 and 6 months tenors, while all the bids for 12-month papers were rejected, 4) the GoP’s plan to issue international Sukuk Bonds worth US$500 million against Islamabad Lahore Motorway for budgetary financing and 5) nearly 13%YoY growth in total cement dispatches to 3.527 million tons in October 2016 due to a rise in infrastructure development.

Though, political tension eased off with PTI calling off its protest, political risk remains as Panama‐gate’s next hearing is scheduled for 15^th of this month. However, analysts expect market to continue its rally led by heavyweight sectors like cements and banks. The monetary policy to be announced later this month is expected to maintain status quo. Also, OPEC meeting later this month in order to decide production cuts may provide boost to E&Ps.  

Results for the US presidential elections place Donald Trump as the US President Elect. While analysts believe that the US foreign policy under Trump presidency can be volatile in nature, there is also a possibility of an overhaul in US‐Pak relations. The republican's campaign rhetoric compels analysts to believe that micromanagement and unilateral actions along Pakistan's borders may ease out under Trump presidency.

In this backdrop, Pakistan has done well by diversifying its foreign relations towards Russia (joint military exercise recently conducted in Pakistan) and China's ongoing ambitions in investing heavily into Pakistan. In line with global markets, near term volatility at the PSX also cannot be ruled out. However, Pakistan market's correlation with regional markets has decoupled on the former's possible inclusion in the MSCI EM Index and momentum for infrastructure and economic development together driving 21%CYTD returns for the benchmark index which is expected to continue in the medium to long term.

Dull exports in continuation of what has been the unflagging trend now, Pakistan exports remained on the lower side for September 2016 at US$1.52 billion as compared to US$1.72 billion for September 2015, down 11%YoY. Total exports registered a decline across all segments, with the highest impact coming from heavyweights Textiles and Food sectors, which were US$961.0 million / US$238.8 million, sliding by 12.1%YoY / 14.7%YoY. Consequently, 1QFY17 total and textile exports were recorded at US$4.68 billion and US$3.03 billion respectively, marking a decline of 9%YoY and 6%YoY.

Going forward, analysts expect textile exports to continue remain under pressure due to: 1) slowing Chinese demand, 2) lack of currency competitiveness limiting GSP plus benefits, 3) concerns of an economic slowdown in the EU following Brexit, constituting 20%‐25% of textile exports, and 4) shortage of cotton supply after tapering cotton production last year with arrivals down by 34%YoY. However, the soon‐to‐be announced export incentive package worth Rs175 billion by GoP, in a bid to reduce the cost of doing business and enhance competitiveness of export‐oriented industries with regional countries, remains a key near‐term trigger for the sector.

Forecasting steady spell of growth for OEMs in the country, sector experts analyze the current value proposition of the three major assemblers, being Japanese in origin. Highlighting the positioning of each in the prevailing market structure, analysts point to avenues for deepening demand of locally produced offerings. Commenting on the rise of Japanese OEMs in the region, they look at falling demand in traditionally high growth markets (Thailand, Malaysia) as a reason to aggressively introduce new offerings, as CKD units are freed up, and may be diverted to high growth markets. FTA being discussed through bilateral arrangements (Thailand, Turkey and Korea) may further this move, but on the flipside, favor new entrants. The case of low price, eco segment vehicles making up a large portion of first time car purchase, in the region, particularly in Thailand may be implemented at home. Price competitive offerings in the 1000CC and below segment make up to 50% of overall passenger sales, while the small economy segment (below 800cc) dominates the import market (4,417 units imported in 2MFY17 making up 52% of total imports).

Implications of Trump victory for Pakistan

In an utmost surprise Donald Trump has been elected President of the only surviving super power, United States (US). Not only residents of many other countries find it a bitter pill to swallow, demonstrations are also being staged in the US, one of the rare happenings in the country enjoying democratic rule of more than two centuries.

I have posted a blog some time back exploring the possible impact of 2016 elections. My bottom line was that the love/hate relationship will be driven by the foreign policy agenda of the super power. Over the last 48 hours I have been going through the global news networks as well as Pakistan to have a better understanding of the likely outcome of shift in foreign policy agenda. This brief is based on the writing of one of Pakistan’s leading brokerage house, AKD Securities.

The brokerage house believes that the US foreign policy under Trump may remain highly volatile, there is also a possibility of an overhaul in US-Pak relations. The republican's campaign rhetoric leads force Pakistanis to believe that micromanagement and unilateral actions along Pakistan's borders may ease out under Trump Rule. In this backdrop, Pakistan has done well by diversifying its foreign relations towards Russia and China's ongoing ambitions in investing heavily into Pakistan.

In line with global markets, near term volatility at the Pakistan Stock Exchange (PSX) cannot be ruled out. However, Pakistan market's correlation with regional markets has decoupled on the former's possible inclusion in the MSCI EM Index and momentum for infrastructure and economic development together driving 21%CYTD returns for the benchmark index which can be expected to continue in the medium to long term. 

Pakistan has suffered the most during the incumbent government of PML-N due to the absence of full-time foreign ministers. Worst of all the two foreign policy advisors are not on the same page. Admitting that these are unchartered waters and while analysts believe that the US foreign policy under a Trump may remain volatile, there is also a possibility of an overhaul in the bilateral relationship as Pakistan has largely remained at the periphery of US interests in this region.

The republican's campaign rhetoric compels Pakistanis to believe that micromanagement and unilateral actions along Pakistan's borders may ease out under Trump. The onus would be on Pakistan to keep its western borders safe as the US pulls out of Afghanistan. As far as the current hostile situation between India and Pakistan is concerned, the US as always will likely encourage both countries to come to the negotiation table. In this backdrop, Pakistan has done well by diversifying its foreign relations towards Russia and China's ongoing ambitions in investing heavily into Pakistan.

Historically, aid flows from the US have fluctuated due to ever changing US geo-political objectives in the region. After nearly a decade of withholding assistance, inflows recommenced in 2002 and scaled up considerably in lieu of Pakistan's alliance with US on counterterrorism efforts post-9/11.

The aid appropriations have accumulated to US$19.07 billion under economic (US$11.1 billion) and military (US$7.9 billion) assistance. Additionally, Pakistan received reimbursements under CSF, forming the largest chunk of inflows with US$14 billion received since 2002. However, actual disbursements - particularly economic aid - have reportedly remained much lower, where EAD data reflects economic grants disbursed to Pakistan since FY07 at US$2.1 billion.

As per a USAID report, disbursements under the Kerry-Lugar-Berman Act (promising US$1.5 billion annual economic support over FY10-14) as of September'15 add up to US$1.8 billion. Following developments in 2011, aid from US has tapered off where economic/security related aid appropriation to the country declined to US$423 million/ US$320 million in FY17. Post-elections, economic assistance is likely to stagnate at current levels while military aid can be considerably scaled back with CSF flows remaining absent (US$300 million yet to be paid) if recent disagreements on action against the Haqani network continue along with withdrawal of troops from Afghanistan.

In this backdrop, Pakistan's macroeconomic focus has been shifting towards the East as the country embraces Chinese investments and positions itself as a beneficiary of foreign direct investment under China Pakistan Economic Corridor (CPEC) from the world's second largest economy.

While US remains one of major destinations for Pakistani exports, the quantum has in fact declined remained to16% in FY16 as compared to 19% in FY09. To recall, Pakistan's recent request for preferential access for textile exports to US was rejected. US is likely to revisit its trade and investment ties under the new leadership, however any trade facilitation to Pakistan remains unlikely going forward.

Similarly, outlook on investment from the US remains bleak (FDI share from the US down to 2% from 23% during FY09-16), where any recovery in the same will largely remain a function of Pakistan's intrinsic business climate. Longer term risks remain in the form of stricter immigration rules that can affect remittance flows from the US that make up 13% of total inflows (already declining due to anti-money laundering laws in US).

Trump's victory can fuel expectations for rate hikes quicker-than-projected currently in the backdrop of Trump's criticism earlier of Fed's policy to hold-off rate increase this year. This entails direct implications for foreign flows to regional markets including Pakistan as was the case in CY15. In this regard, upcoming FOMC meeting in December'16 will be crucial to track changes in the Fed's outlook. On the other hand, greater volatility in global financial markets due to an uncertain US policy outlook can propel the Fed to delay a hike to next year.

In line with global markets, near term volatility at the PSX also cannot be ruled out. However, Pakistan market's correlation with regional markets has decoupled on the former's possible inclusion in the MSCI EM Index and momentum for infrastructure and economic development together driving 28%CYTD returns for the benchmark index.

Pakistan Stock Exchange benchmark index up by almost 5 percent

Investors returned to stock market on reduction in political noise after the Supreme Court initiated hearing on Panama leaks. The benchmark index of Pakistan Stock Exchange improved by nearly 5% WoW and closed at an all‐time high of 41,842 points. Apart from diffused tensions in the political space, positivity emanated from the announcement by KEL of planned shift in ownership to the Chinese power conglomerate Shanghai Electric Corp and the recent imposition of anti-dumping duty on Chinese steel imports as a protectionist move benefiting local players.

News reports during the week included: 1) Petroleum Minister Shahid Khaqan Abbasi announced that the GoP has decided not to increase the natural gas tariff for any category of consumers because of a decline in the cost of producing gas, 2) Minister of State for Water and Power stated that the GoP would likely renegotiate the terms and conditions of handing over KEL to the Shanghai Electric Power Company and expressed confidence in the Shanghai Electric's ability to overcome the power crisis in Karachi, 3) French automaker Renault announced to start assembling cars in Pakistan by 2018 under the newly approved incentives announced in the Auto Investment Development Policy. Renault would enter the Pakistani market as a Joint Venture with GHNL, committing to invest US$100 million in Pakistan and 4) the cut in sales tax on petroleum products reducing an estimated more than Rs20 billion revenue of the FBR during the last four months.

While gainers at the bourse were: MTL, SHEL, ASTL, and ICI, laggards were: EPCL, AKBL, MEBL and CHCC. With the reduction in political noise, the market is expected to rally on the back of hastening inflation matching a bottoming out of the interest rate cycle, a positive for banks. Additionally, as November meeting of OPEC ministers approaches closer, any news flow on production cuts could trigger global oil price momentum.

S&P Global upgraded Pakistan's sovereign rating to B/stable from B‐/positive driven by successful follow through on IMF dictated reform agenda. Major macro metrics qualifying the country for an upgrade are: 1) fiscal consolidation to 4.6% of GDP, 2) external account strength and 3) greater monetary flexibility. The agency maintains an optimistic outlook on the country's economic prospects, projecting 5-year GDP growth at 5% (FY16‐19) primarily on the back of CPEC related development. Looking ahead, analysts expect Pakistan to maintain credit rating at current levels over the next year, where probability for another upgrade remains low. Their view emanates from the need for stringent reforms in tax collection to support Pakistan's debt affordability (external debt up 20% over 3 years). However, likelihood of the current GoP turning to populist measures can hamper revenue boosting efforts and consequently eligibility for an upgrade.

K‐Electric (KEL) has notified that KES Power (Abraaj‐controlled) entered into an agreement to divest its 66.4% shareholding in KEL to the Shanghai Electric Power Company Limited (SEP). At a disclosed deal size of US$1.77 billion (Rs184.2 billion), the deal price works out to Rs10.05/share. As SEP is acquiring a majority stake in KEL and the shareholding of KES Power Ltd is shifting from Abraaj and Al-Jomiah/NIG to SEP, a tender offer is likely for 50% of the remaining shares voting shares. In this regard, regulations (Listed Companies Takeover Regulations 2008) suggest that the tender may be offered at the SPA price (which is the highest amongst the stated criteria). Despite risks evident in the operation environment of KEL, analysts opine that SEP (of which the 43.0% is owned by the State Power Investment Corporation) will be on firmer footing to negotiate with the GoP concerning crucial operational aspects (PPA with NTDC, renewal of MYT, generation licenses).

During this past week, Cherat Cement Company (CHCC) became focus of investors’ attention for two reasons, announcement of attractive quarterly financial results and COD one month earlier than planned. The Company announced its 1QFY17 financial results posting profit after tax of Rs404 million (EPS: Rs2.29), registering 51%YoY growth over net profit of Rs268 million (EPS: Rs1.52) for 1QFY16. Key highlights of results were: 1) Topline grew by 14%YoY to Rs1.77 billion due to improved dispatches, (2) gross improved owing to cheaper energy cost and 3) tax expense jumped 97%YoY due to 61%YoY higher pre-tax earnings and effective tax rate of 27% as compared 22% in 1QFY16.

CHCC's 1.3 million tons per annum (tpa) expansion is expected to achieve COD by end November 2016, one month earlier than its plan. Currently, the new line is under testing. Being the first of expansions in the current cycle, CHCC can gain significant market share as other major manufacturers are operating above 90% utilization, while the next contender, Lucky Cement is not expected to commence production before end CY17. In this regard, AKD Securities report forecasts CHCC's incremental production to result in growth in revenues. Likewise, its market share will also increase, boosting its EPS.

OGDC discovers hydrocarbons reserves in Sindh

 Pakistan’s largest oil and gas exploration company, Oil and Gas Development Company (OGDC) has discovered hydrocarbons reserves in Sindh’s Ghotki and Khairpur districts. This has been stated in a communique sent to Pakistan Stock Exchange on Thursday.

According to the details the three discoveries – at Gundanwari-01, Mithri-01 and Khamiso-01 wells – would cumulatively add up to 29mmcfd gas and 15 barrels per day (bpd) of oil. It would increase OGDC’s earning by Rs0.40/share.

At Khamiso-01 in Ghotki, a joint venture of Guddu Block – comprising of stakes as OGDC as operator (70%, SEPL (13.5%), IPRTOC (11.5%) and GHPL (5%).

The structure of Khamiso-01 was drilled and tested by OGDC’s in-house expertise. The well was drilled down to the depth of 753 meters, which tested 2.95mmcfd of gas through 32/64-inch choke at wellhead flowing pressure of 505 PSI from Pirkoh Limestone formations.

At Gundanwari-01 in Khairpur district, where OGDC is an operator with 95% stake and Government Holdings (Pvt) Limited has remaining 5%, the well structure was delineated, drilled and tested. The well was drilled down to the depth of 3750 meters. It tested 19.40mmcfd of gas and 15bpd of Condensate through 32.64-inch choke at wellhead flowing pressure 3300 PSI from Lower Goru (Massive Sand) Formation.

Next US President: Hillary or Trump

The fast changing poll results are creating more confusion, rather than providing a credible forecast about the outcome of US presidential elections being held on 8^th November 2016. Around the world Muslims and particularly Pakistanis are anxiously awaiting the official announcement. I posted a blog on Wednesday exploring the possible implication of the outcome on Pak-US relationship. The bottom line was that whoever wins the election ‘status quo’ will remain, meaning the relationship will get good if Pakistan’s services are needed or will get bad if the US focus shifts to other regions.

Some of the readers of my blogs asked a funny question, who will win the election? I wondered if they believe I have a crystal ball or I am a fortune teller. Despite knowing my inadequacies I sat down to explore the probability. Born in a third world country, having witnessed domestic, South Asia and MENA geopolitics for nearly half a century I have also started believing in conspiracy theories. Based on my observations, I tend to say that Hillary Clinton could be the next US president. The reasons are following:

The US ruling junta has created a history by electing a black and half Muslim President. This time they will create another history by electing a woman as US president.

It is often said that in third world elections are engineered. I tend to say that the elections are also engineered in the US and the active players are part of electoral system. This time the female members of the system will play a decisive role. I say this because often the female members have not played a key role, some reports say they prefer to abstain from casting their vote.

A closer look at the outcome also indicates that the elected president should be from Republican. However, it the ruling elite are adamant at making Hillary the next president, they will not hesitate in violating this norm. If they want to continue proxy wars, maintain US hegemony in South Asia and MENA and even South China Sea they have to elect Hillary who is known as ‘queen of status quo’.

   

Pak-US relation after the election

Elites as well as commoners of Pakistan while passing time in their drawing room talks often indulge in discussions on a variety of topics. These range from civil-army relations to Pak-India border situation to proxy wars going on in the neighborhood. However, lately the talks also drift to the outcome of US elections and US-Pakistan relations in the aftermath. The diversity of discussion depends on the knowledge of the participants about the facets of the US foreign policy.

The commoners often have the consensus that historically the successive governments in Pakistan have been towing the US foreign policy agenda since independence. They also say that Pakistan’s foreign policy has mostly remained under the shadow of US foreign policy. However, there have been good and bad patches, good during the time US needs Pakistan and bad when the US focus shifts away from the region where Pakistan is located.

During cold-war era as well as Afghan war, Pakistan was often termed key partner in war against terror, but mantra of many US senators and congressmen remains ‘do more’. Pakistan has played a contradictory role in Afghanistan, a friend as well as a foe. Pakistan with the help of Taliban fought against Russian troops but post 9/11 it was asked to fight the same Taliban.

The US is often termed the biggest democracy of the world, which also take active part in ‘regime change’ programs around the world to dislodge ‘dictators’. However, it is worth noting that the US has supported three dictatorial regimes in Pakistan, spread over nearly thirty years. Supporting these regimes was need of the super power, as it believes that negotiating with a dictator is easier as compared to an elected/democratic government, which is accountable to the masses.

This is not unique, the US has been installing, supporting and even prolonging and dislodging dictators’ rule in many countries in the name of ‘regime change’. Surprisingly, the biggest democracy of the world does all this but its citizens and/or elected representative, in one way or the other, endorse acts of ruling junta. One may say that the deception prevails over only because of the much talked about liberal media that is not free in real sense.