State of Pakistan Economy

Pakistan’s central bank, State Bank of Pakistan (SBP) has recently released its Annual Report for the financial year ended 30th June 2016. The Report is full of praises of the economic managers for achieving targets under prevailing difficult circumstances. However, it also highlights the serious problems facing the country. The bottom line is that unless right structural reforms are undertaken the country may once again plunge deeper in serious crises, worst being balance of payment crisis. I would talk about praises later as I consider it my ardent duty to first highlight the problems facing the country.

Notwithstanding these positive macroeconomic stability gains, the Report highlights some challenges as well. Firstly, the current level of private investments and savings in the country needs acceleration to keep pace with required investible resources. Secondly, structural issues in the export industry need to be resolved. Thirdly, the reliance of the tax system on stop-gap measures is creating distortions in the economy. Finally, the country needs to spend more on social sector development to address social issues.

The Report, considers Pakistan to be well positioned to address these challenges. It anticipates all-important support coming from a stable macroeconomic environment and growing investments in CPEC-related projects. These would help improve the existing infrastructure and power supplies to businesses. Some analysts don’t agree with this rationalization.

The Report recognizes the positive impact of improved macroeconomic environment, better energy supplies, and subsiding security concerns. The central bank believes that in addition to CPEC, economic activity would benefit from pro-growth policies. It specifically says that the current policy rate, at a historic low of 5.75 percent has made funding easier for businesses and consumers. Similarly, growing development spending, despite a planned reduction in budget deficit, would continue to support infrastructure-related industries. One also tends to disagree with this because bulk of the deposits are being invested by commercial banks in government securities rather than extended to private sector.

The Report further explains that though some macroeconomic indicators were short of targets, they still posted better performance over the last year. For instance, real GDP growth of 4.7 percent during FY16 was below its target, but nevertheless higher than the growth achieved a year earlier. Meanwhile, the accumulation of the country’s foreign exchange reserves reached an all-time high level at end FY16; the exchange rate remained stable; and CPI inflation fell to only 2.9 percent during the year. Similarly, fiscal consolidation remained on track, and the budget deficit was reduced to 4.6 percent of GDP – the lowest since FY07. All this is not due to any good policies adopted by the government but lower international prices of crude oil.

The government envisages a GDP growth of 5.7 percent for FY17. The current account deficit is likely to stay in the range of 0.5 – 1.5 percent of GDP during the current financial year. The Report draws attention to the IMF program’s contribution in restoring macroeconomic stability and confidence of international creditors. Crucially, it maintains that the reform process – related to energy-sector, loss-making PSEs (like PSM, PIA), and business-friendly regulations – must continue after the IMF program’s completion.

Finally, the Report reiterates that without private sector participation, it will be hard to achieve a higher and sustainable growth that is built on the pillars of entrepreneurship, innovation and competitiveness.

The detailed Report is available at SBP website www.sbp.org.pk

Pakistan Stock Exchange witnesses 7 percent decline in average daily trading volume

During the week ended 18^th October, Pakistan Stock Exchange remained under pressure due to external and internal pressures. While India continued medium and heavy artillery shelling across the line of control (LoC), Panama case hearing added more confusion rather than providing clarity. As a result the benchmark Index closed 1.2%WoW lower at 42,325 points. Daily average trading volumes also declined 7.1%WoW to 458.6 million shares. Top gainers for the week included: HASCOL, EPCL, PIOC, CHCC and NCL; while losers were: INDU, ICI, ASTL, SSGC and DAWH.

Major news flow for the week included: 1) GoP rejected bids worth Rs113 billion (against a target of Rs50 billion) for this month’s auction of Pakistan Investment Bonds (PIB) as banks sought higher interest rates, 2) SBP reduced SLR for Islamic banks and banking branches by to 14% to induce liquidity near Rs225 billion Bai‐Muajjal maturity, 3) Vitol announced plans to acquire another 10% stake in HASCOL exercising its call option that would take cumulative holding to 25 percent, 4) Oman Telecommunications’ Chief reiterated plans to sell the company’s controlling stake in WorldCall Telecom, 5) Lucky Electric Power Company revised proposal for its planned 660MW power plant following a shift in fuel source to local coal with the EPC arrangement expected to be finalized by before 2016 and 6) SECMC expects to begin commercial operations for its 660MW Thar coal‐fired power project by June’19.

With room for escalation in political tensions on developments on Panama case, delayed till 29^th November, market is likely to remain lackluster. Moreover, futures rollover next week along with possible continuation of foreign outflows is likely to keep market under pressure. Anticipations regarding this month’s monetary policy statement are expected to remain in favor of a status quo, giving support to banking scrips. Continued weakness in coal prices (a decline by almost 18%WoW) can propel price performance in the cement sector while volatility in crude prices ahead of OPEC meeting scheduled on 30^th November may prompt higher activity in energy stocks.

According to AKD Securities, 9MCY16 earnings performance of Bank Alfalah (BAFL) was laudable on a number of counts, especially in terms of improvement in asset quality and effective Current Account mobilization. Flagging NPL ratio of 5.4% ‐ the lowest among ‘Big-Six), the bank's provisioning charges have come down by a sizable 79%YoY to Rs267 million, while coverage has increased to 83.1% in 9MCY16. Gaining confidence from the same, the brokerage house is now more comfortable on the bank's asset quality metrics and has lowered its provision charges. In turn, the bank's CASA hiked to 79% as compared the same period last year, lowering cost of funds. The brokerage house believes there are chances for further trimming, where apart from the aforementioned factors, CAR enhancement to 14.1% and ADR in excess of 50% depicting bank's push for loan growth are additional positives.

Lack of encouraging news flows, following a shift in policy for coal fired power plant (refusal to allow imported coal projects), lack of headway on circular debt clearance and privatizations have weighted on the energy sector companies, with HUBC and KAPCO posting a decline of about 12 and 13 percent FYTD. The impact on future growth projects (limiting of size and scale of planned expansions) from an adverse policy environment may be sizeable, holding down valuations and profitability in the long run.

According to the monthly automobile sales and production data, total vehicles sold reached 16,330 units (down 1.5%MoM and 17.2%YoY) during October this year. The sale comprised of 14,796 passenger cars (increasing 1.2%MoM but down 5.8%YoY) and 1,534 LCVs (falling 22.2%MoM and 61.8%YoY). The halving of GST on tractors allowed sales to climb by 46.3%MoM/93.2%YoY to 4,642 units. Monthly numbers point to a systemic consolidation in unit sales as consumers adjust buying behavior to accommodate for new models, while OEMs phase out models (Hilux by INDU and possibly Cultus by PSMC). Buying behavior is expected to ramp‐up in the beginning of CY17 with newly registered automobiles experiencing an increase in demand, additionally, auto sales growth is expected to normalize in 2QFY17, where the high base of the Rozgar scheme sales normalizes.

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.