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Upcoming political events may further pressure confused market confidence

Investor’s confidence remained muddled over indecisiveness exhibited on the political front (appointment of caretaker prime minister) during the week ended 25th May 2018. The benchmark index of Pakistan Stock Exchange witnessed an increase of 450 points at 42,074 level, up 1.1%WoW. The failure of Sindh, Punjab and Balochistan governments to introduce any noteworthy schemes or development outlays for FY19, and the failure of the Khyber Pakhtunkhwa (KPK) government to propose any bill, kept sentiment subdued.

Key news flows impacting the market during the week were: 1) current account deficit for 10MFY18 exceeding US$14billion, up 50% on the back of increasing imports outweighing exports, 2) National Assembly passing Budget for financial year 2018-19 along with the tax amnesty scheme, 3) Election Commission of Pakistan proposing dates for the upcoming General Election, 4) special delegation leaving for Bangkok to attend regional FATF meetings and 5) foreign exchange reserves of the country slipping below US$17billion mark after erosion of US$415million during the last week, mainly due to debt servicing. While gainers of the week were: EFOODS, GWLC, MLCF, BAFL and PPL, laggards included: PSMC, LUCK, APL, INDU and KEL.

Average daily trading volumes increased almost by 4%WoW to 119.50million shares with FABL, PAEL, FCCL, BOP and FDIBL being the volume leaders. The central bank raised policy rate to 6.5% (highest in almost three years). The hike in interest rate is likely to revive market sentiments particularly with regards to the banking sector going forward. However, any turbulence in upcoming scheduled political events (dissolution of national parliament due on 31st May 2018) could bring the market under pressure in the near term.

State Bank of Pakistan (SBP) in its latest Monetary Policy Announcement raised its Policy Rate by 50bps to 6.50%, which was higher than market expectations. The central bank had raised rates by 25bps to 6% in January 2018 after 4 years. SBP cautioned that the balance of payments situation has deteriorated despite some rise in exports due to sharp increase in international oil prices and limited financial inflows to date. In the absence of sufficient inflows, country’s own resources were used to finance the external deficit during last ten months of the current financial year that led to the country’s foreign exchange reserves declining by US$5.8billion to US$10.3billion as of 18th May 2018.

SBP expects inflation to remain relatively in control despite the recent rise in core inflation, where Non-Food Non-Energy (NFNE) inflation rose to an average 6.4% during the last two months. The rising trend in international oil prices is expected to result in cost-pushed inflation. SBP acknowledged that the real sector has posted broad based growth in FY18. However, the government’s GDP growth target of 6.2% for FY19 seems ambitious and achieving it will depend on effective handling of external challenges. This may force the central bank to increase interest rates during CY18 by another 75 basis points in order to curb spiraling aggregate demand and imports of the country.

 

Current account deficit for April 2018 surged to a record level of US$1.96billion compared to US$1.2billion in March 2018. Despite contained trade deficit, the current account deficit widened on account of jump in primary income outflows, up 46.9% MoM accompanied by US$329milliondecline in current transfers and remittances down by 6.9%MoM. Consequently, current account for 10MFY18 reached US$14.0billion, up 50.0%YoY from US$9.4bn in the comparable period last year. This has been primarily on the back of growing trade deficit recorded at US$25.0billion, as import grew by 17.1%YoY exports increased by 13.3%YoY, while remittances increased marginally by 3.8%YoY. Going forward, as trade deficit continues to widen, current account deficit is expected to remain on downward trajectory and post a deficit of around US$16billion for full year (FY18) though seasonal jump in remittance inflows during Ramazan could provide some relief.

The latest data released by the government shows that country’s total exports continue to post double digit growth. Exports during April 2018 rose to US$2.13billion, up 18.6%YoY. A likely impact of recent rupee depreciation (9.5% since December 2017), both food and textile exports were up 37.6%YoY and 12.1%YoY, respectively. In textile group, both value and low value added exports grew to US$822million and US$327million. On a cumulative basis, 10MFY18 textile exports grew by 8%YoY to US$11.14billion as compared to US$10.31billion during 10MFY17, with value added exports up by 9.6%YoY to US$8.12billion. Low value added exports which remained largely sanguine in the first half strongly recovered in the second half with segment exports reaching US$3.025billion, up 4.1%YoY. Going forward, analysts expect textile exports to maintain their upward trend as the sector would continue to benefit from strengthening economic activity in key export markets, flexible exchange rate regime and continued government support (likely extension of export incentives and tariff subsidy). However, prolonged delay in payment of exporters’ refunds could undermine utility of export package posing downside risk to export outlook.

The banking sector remained under pressure over the last two months and witnessed erosion of 5.4% — making it amongst the worst performers. The sector is again in limelight for all the wrong reasons, with recent budgetary proposals (super tax continuation), regulatory challenges (additional capital requirements by SBP, increase in minimum pension rate to Rs8,000/month) and increased oversight on foreign operations have been key dampeners. With regards to super tax applicability, an AKD Securities reports forecast banks’ earnings to go down, while additional capital enhancement requirements can restrict banks’ ability (particularly those that remain insufficient on the CAR front) to participate in the credit up cycle and dividend payouts.

Consequently, CY18 is likely to be another slow year with earnings deceleration primarily a function of exogenous factors during the year. That said, recovery thereon should be swift (CY19F earnings growth of average 24%) particularly in the absence of one-offs while fundamental triggers (increasing interest rates) should becoming the key determinants of the profitability of the banks.

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