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Pakistan stock market at a crossroad

Inconclusive IMF talks have extended market uncertainty, but a lack of definitive bearish movement indicates money managers are paying due attention to eventual money inflows from different avenues, Saudi Arabia, China and International Monetary Fund (IMF).The timing of fund flows is crucial and holds the key to market direction where negative narrative on fund flow is being countered by positive narrative on eventuality of the same as well as economic benefit of current low oil price. Historical average returns post an IMF program have been slight positive in the 60 and 90 days prior to entry. Current economic situation somewhat resonates with 2001 with IMF program a constant and aid flow from US replaced by China and Saudi Arabia.

Lately, market appeared directionless, consolidating as a tussle between bears and bulls ensues, negatives for the market included 1) uncertainty over amount and disbursement from Saudi Arabia and China and 2) delays in the finalization of an IMF program. On the flip side, the biggest positive was receding oil price, both Brent and Arab Light. The short term negative for the Pakistan market was a 15.2% weight of E&P, portends a big positive for Pakistan over the medium to long term. For Pakistan, very US$5/bbl correction in oil price results in a reduction in trade gap by US$1.1billion. At the same time, money managers may potentially eye a strong closing to the year which may aid market momentum.

Talks with IMF remain inconclusive and the Government of Pakistan (GoP) and IMF failed in reaching staff-level agreement on the prospective IMF bailout. Reportedly, the major area of contention is pace of adjustments to address the macro-imbalances. The IMF wants a front loaded program where it seeks broad upfront macro adjustments, while the GoP intends to adjust the imbalances in a more gradual manner over the program period. Encouragingly, both sides have made significant progress on ‘broader policy and structural reforms framework’ for the prospective IMF program with negotiations set to continue. Select details from the recently held round of negotiations reveal key demands of the IMF include 1) raising tax to GDP ratio by 0.5%, 2) a further hike in utility prices to the tune of 20%, and 3) clarity on funding arrangement with friendly countries particularly China.

For further clarity I am inclined to refer to a report by AKD Securities regarding corresponding returns pre and post beginning IMF programs. On a net basis, Pakistan needs funding support of US$15billion over the next two years where successful disbursement of Saudi support should provide leeway for a year, while Pakistan also needs at least $6billion immediate support from China and others. The remaining $6-8billion funding is currently being negotiated with the IMF. The lack of bearish market sentiment indicates money managers factoring in money flow from different avenues.

 

Timing of the flows is crucial and likely to set the tone for market movement. Historically, the KSE-100 Index has depicted average negative returns during first month post an IMF program entry but positive returns in second and third month thereafter. Of particular prominence is the IMF program in 2001 where market depicted returns of negative 1.3%, positive 21.9% and positive 32.5% in the first, second and third month post beginning of IMF’s SBA. The situation appears similar to 2001 given the KSE-100 Index at the time had pared gains of 21% 2M before the entry into an IMF program. The 2001 and thereafter period had been characterized by fund flows from the US, where FY19 and onwards is being characterized by fund flows from other countries (China, Saudi Arabia), even though the nature of flows is substantially different.

Morgan Stanley Capital International’s (MSCI) announced its November 2018 Semi-Annual review wherein it removed United Bank (UBL) and Lucky Cement (LUCK) from MSCI Global Standard Index Pakistan, all changes will be implemented from the close of 30th November 2018. After this exclusion, Pakistan’s weight in MSCI Emerging Market (EM) index is expected to fall to 0.037% from earlier 0.075% and from 0.055% as per 23rd October 2018 closing.

UBL and LUCK have now been demoted to MSCI Global Small Cap Index where MSCI has removed Honda Atlas Cars (HCAR) and Maple Leaf Cement.The removal of UBL and LUCK from MSCI Global Standard Index Pakistan was due to their decline in market capitalization, falling below 2/3rd of MSCI’s set criteria for Free Float and Full market capitalization.With this, Pakistan will be left with a total of 25 constituents in MSCI Pak Investible Market Index (IMI) where 3 constituents Oil & Gas Development Company (OGDC), Habib Bank (HBL) and MCB Bank (MCB) are part of MSCI Global Standard Index Pakistan.

MSCI also revised down its Free Float and Full Market Capitalization criteria by 7% to US$741million and US$1482million, respectively. MSCI’s price cut-off for this Semi-Annual review was any one of the last 10 business days of October 2018. While Pakistan’s market has recovered after 23rd October 2018 after Saudi Arabia’s announced financial package of US$6billion, it remained under pressure throughout the year.

From January 2018 till 23rd October 2018, LUCK was down 21% (Free Float and Full market cap. down 35% and 65% to $393million and $983 million respectively, while UBL was down 28%, Free Float and Full market cap. down 40% and 60% to $1,243million). KSE-100 Index during the same period lost market capitalization of $20billion (down 2,756 points or 6.8% in Pakistan rupee terms and 23% in $ terms) on the back of pressure on external account front. Moreover, dollar against rupee during the aforesaid period appreciated by 21%.

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