Our views on Pakistan’s economy and market

Dear Friends,

May this month bring happiness, joy and peace in our lives, families, society and country.

Control and not ownership

My last week’s blog on control on ownership of companies listed on Pakistan Stock Exchange went viral (10k+ views). I received many emails and comments. A few highlighted that I missed some families such as the Lakson Group and Arif Habib. Point well taken. Some pointed out that our email title regarding owneship is not correct. This is true. We were measuring control of the companies and not the value of the ownership. Our calculation included 100% of the value of the companies and also of their holding companies for each group. For example for JS Group, our data was adding 100% market cap of the companies in which the family has significant shareholding (>10%) either directly or indirectly through another company. So the blog was measuring “control” and not value of ownership. Updating the data for the 2 families, the correct statement will be that top 13 family groups have collective control (via significant shareholding) in companies which account for 40% of the total capitalization of Pakistan Stock Exchange. I was told that my blog has made the tax authorities in Pakistan vigilant, so its important for them to see this clarification.

Money supply and KSE100

A dear friend of mine, who is the top EM economist in a leading bank on the Wall Street, shared this chart with me, which plots the change in M1 money supply and the year over year change in KSE-100 Index.
The data shows remarkable correlation. Not only does do the two data series follow large trends but even mirror the short term fluctuations.
As my friend pointed out, the results from this analysis suggests that the only relevant variable for forecasting stock market performance is the growth in money supply. If true, this would indeed make our jobs much more simpler and effective!
Another interesting read through is that the data is tracking a measure of “narrow money”. This means that is not impacted by variables such as the money multiplier, which is driven by how much of the money supply created by the Central bank is further lent out by the commercial banks.
State Bank’s data (taken from Zakheera) shows that while both M2 and M0 money supply have increased over the last ten years, M2 growth has been more volatile.

Money supply growth (YoY %)

Source: Zakheera.com

Debt Monetization

One explanation for the growth in MO money supply could be “debt monetization” by the SBP. I suppose in simple words this means printing of money in order to finance the borrowing (and spending) of the treasury. Indeed the growth in narrow money has been almost entirely driven by growth in notes in circulation (click here for SBP data). By end of March 2018, total notes in circulation in Pakistan were PkR4,085bn and they have increased by 16% CAGR over the past ten years.

Source: State Bank of Pakistan

This would also indicate that the biggest source of domestic liquidity in the economy comes from government spending. KSE-100 goes up when the SBP increases the pace of printing money and the rise in KSE100 slows down when the SBP slows down the money printer.
Typically note printing leads to higher inflation, as it did during the 90s, however, inflation has been quite benign over this cycle. Last year the inflation was actually below the target. This is quite encouraging as it indicates that there is still excess capacity and the economy has not yet reached its full capacity. Nevertheless, we still expect inflation to exceed this year’s target of 6%. In our view, exchange rate depreciation along with rising energy prices could lead to sharp rise by the second half of the year.

We think June will be a critical month for investment planning perspective. Not only will the debt position become more clearer but more importantly the review meeting of Financial Action Task Force (FATF) is also in June. We think this could be a significant event for the market and the economy.

Revisiting digitalization

Looking at the SBP, we found it interesting that cash usage in Pakistan has been rising over the past 5 years and is now at around 12% of GDP. This is similar to other markets such as the US. The outlier is Sweden where cash usage accounts for less than 2% of GDP and the government is targeting it to decline to less than 0.5% by 2020. Indeed this is a tough task as can be seen from the Indian experiment with demonetization which shows that even taking 80% of the bank notes out of the system did not significantly reduce cash usage. In my opinion, one of the big hurdles against the adoption of the digital transaction is the threat of the taxman (it works everywhere). Consequently, in Pakistan, the recent tax rule which limits the sale of the car to tax filers, is likely to create some near term headwinds for the auto-sector. Since the rule does not apply to second-hand cars, it might lead to a greater shift towards car resales.

Source: State Bank of Pakistan

In my view, the shift to the digital economy will happen due to market forces and the natural adoption of more convenient services rather than a push by the state. Since the start of the year, the investment of Ant Financial in Telenor Easypaisa and the acquisition of Daraz by Alibaba has put Pakistan on the radar of global VC/tech giants. As we wrote on our March report, we have high conviction that the next wave of earnings growth and investments will be driven by the tech sector.

Our Equity Sales team expanded with the addition of Kamlaish Kumar. Kamlaish has over 15 years of experience in the industry and had taken a break to do an MBA. We welcome him to our team. He can be reached at k.kumar@kasb.com.

Ramzan Mubarik!

I am, yours truly,

Muhammad Ali

Ali Farid Khwaja, CFA
Khadim Ali Shah Bukhari Securities

Trade with us. Download forms to open an account with us from here.

Research Views

Autos: Cyclical concerns could create good entry points

We initiated coverage on the Auto sector on 9th of May 2018 with stock initiations on Indus Motors, Honda Atlas Car and Pak Suzuki Motors. We think the sector could remain under pressure due to cyclical headwinds, especially due to unfavourable FX movements. However, we think the structural drivers will remain intact and companies like Indus Motors could be well positioned to deal with the headwinds. Our industry channel checks confirm our view that Indus has a strong brand and pricing power. Indus has a strong balance sheet (15% of market cap is in cash), cash generative business model (8% FCF yield) and benefits from high barrier to entry.

Pakistan: Digitalization Boom & CPEC Wave

In this report, published on 1st March 2018, we tracked more than 500 early-stage tech companies in Pakistan and produced the first market map of the sector. We think digitalization will drive the next wave of earnings growth and investment returns. On the back of the report, we hosted the first Tech Investment Conference in Pakistan. Hadi Hafeez, our digital analyst focuses on this sector and is on the looking out for interesting companies.

Banks: Digitalization, Consolidation & Compliance

We initiated coverage on the banking sector on 11th of April 2018 with stock initiations on UBL, Bank Alfalah, MCB and HBL. We think digitalization could lead to 120-150% increase in the profits of the sector over the next 5 years and would drive relative out performance. The other two drivers of share price returns would be consolidation and compliance risks. Please contact us if you want the full report