Balance of Payments: Is winter coming?
This is why for this week’s picture in the newsletter, we have selected snow capped and rugged mountains of the Karakorum. It reflects how the road ahead, could be winding, challenging and steep.
We recommend caution.
The Dar Dutch Disease
To quote from the letter “The record level of external borrowings during the last three years has led to a form of ‘Dutch Disease’. Larger reserves, based completely on external borrowing, have created artificial stability in the value of the rupee, thereby reducing competitiveness. Enhancement of electricity tariffs by over 40percent and gas price to industry by 64percent, further affected competitiveness. In an effort to meet the Program revenue targets, FBR has held back over Rs 200 billion of refunds, leading to liquidity problems for exporters. Further, levy of a minimum import duty on raw materials and intermediate goods has added to costs. [This] has adversely impacted on growth and employment in the country and frustrated the achievement of greater self-reliance“.
They predicted that by 2017-18 our external funding requirement would have swelled to $18bn.
The interesting and insightful thing is not only the fact that these issues are now recognized by even the Government (click here) and the IMF has done a 180 turn on their assessment of the state of the economy but also the fact the two of the three authors are reported to be in consideration for economic management role in the interim government.
Another top economist and former Governor of the State Bank of Pakistan, Dr. Shahid Kardar (also in the press as a candidate for interim government) published an article on the likely path ahead if Pakistan was to go to IMF for a bailout (click here for the article). According to Dr. Kardar, not only could the negotiations be tough due to political influence of US government but even otherwise, a bailout could be conditional on exchange rate adjustments and sale of PIA.
Buckle up and look ahead
You can probably sense that there is Ra Ra Rasputin playing somewhere in the background. Not a surprise that the Chief Justice of Pakistan is now interested in seeing the former finance minister in the court according to the press (see news here)
As we wrote in our last report, the best things about cycles is that they eventually turn. So we can look forward instead of dwelling on the past.
It is quite clear that the road ahead requires a focus on exports, attracting foreign investments and substitution of more expensive energy sources with cheaper ones. This would require exchange rate adjustment (we expect PkR to reach 125 by the end of the year). Structurally, export driven sectors such as Textiles could come into play. However, in line with the views we have written on earlier, we are most positive about the digital economy and continue to see massive scale and potential in software exports.
Bloom and not just gloom
Recently I was shared a Bloomberg article on Linkedin, which showed that Pakistani currency has been very stable over the past 5 years (see chart below). For me the interesting thing was not that the PkR only depreciated by only 14.8% but that all EM currencies have gone through adjustment. Despite of this equity valuations in India, Malaysia, Mexico, Indonesia, Turkey etc are substantially (20-40%) richer than those on PSX. So we dont believe that artificial adjustment of the FX rate brings any structural credibility for investors. The problem with the current state of affairs is that the Central Bank has run down reserves to defend the exchange rate. With less than 3 months of import cover, central bank’s policy has run out of credibility and the exchange rate adjustment is likely to be steep. This means that potential investors would want to wait on the sides until the exchange rate move has played out. So we wait until the interim government comes in and updated us regarding the actual state of the economy. Till then buckle up for the cycle.
Over the next few weeks will be expanding our research coverage to additional sectors and stocks. Please contact us if you want to open stock trading account with us and get our investment views and service.
We look forward to working with you.
I am, yours truly,
Ali Farid Khwaja, CFA
Khadim Ali Shah Bukhari Securities
Trade with us. Download forms to open an account with us from here.
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
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.