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PSX one of the worst performing markets in FY19

Pakistan stock market witnessed a substantial decline of 12% in Rupee terms and 23% in US$ terms during 4QFY19 amidst macro-economic uncertainties. Major decline was posted in the second half (Jan-Jun 2019 with a fall of 9% in Rupee terms and 21% in US$ terms). During the outgoing fiscal year, the benchmark index of Pakistan Stock Exchange (PSX) plunged by 19% and 39% respectively for the second consecutive year. The aggregate fall for the last two fiscal years was to the extent of 27% and 52% respectively.

Market capitalization plunged by 53% in the last 2 fiscal years, from US$91 billion to US$43 billion in FY19 alone primarily on the back of worsening economic conditions and significant Rupee depreciation. Market activity also remained muted as average daily volume fell by 11%YoY to 155 million shares, while in PKR terms value per day settled around Rs6.4 billion, down by 22%YoY in the cash market. Furthermore, in the futures market, average volume per day was up by 14% to 69 million shares while the average value per day was down by 19% to Rs2.7 billion, respectively.

US$ currency strengthened significantly by 14% in the last quarter against local currency, taking total FY19 gains to 32%. During the last 2 years, greenback has gained approximately 53% against Rupee.

Amongst regional markets, PSX was one of the worst performing; down by 23% and 39% during 4QFY19 and in FY19 respectively. Though, foreign investors remained net buyers in the last 2 quarters, they emerged net sellers during the FY19. Foreigners as per NCCPL data bought shares worth US$ 1,501 million and sold US$ 1,857 million in FY19, resulting in net selling by US$ 356 million.

In terms of investors’ participation, June 2019 witnessed outflow of US$4.94 million. The major outflows were recorded in E&Ps (US$15.5 million) and Fertilizers (US$2.8 million), as against this, inflows into Commercial Banks were recorded at US$8.3 million). FIPI for the full year witnessed cumulative outflow of US$355.6 million, led by outflows from E&Ps (US$145.2 million) and Commercial Banks (US$101.7 million). LIPI flows showcase the vital role now played by individual investors (net buy of 165.7 million), moderated by rising outflows from Mutual Funds (US$145.6 million).

Major event risks are seen to reach a more conclusive note over the outgoing month, with Budget FY20’s targeted levies, tax collection and widening of taxable base beginning a ‘Long road to redemption’. Moreover, significant headway on meeting the terms of an EFF program with the IMF (yet to be approved first announced by the Executive Board), where measures adopted in Budget FY20 to widen the tax net are considered a step in the right direction to address fiscal targets. Additionally, passing marks from the FATF plenary meeting (stressing room for further compliance in the upcoming meeting in October this year) and MSCI’s move to keep Pakistan in the EM index have subdued event risk originating from these sources.

Slippages on the external side particularly in the management of exchange rate parity promoted a risk-off sentiment, exacerbated by: 1) geopolitical tensions in the region where accusations were traded between regional foes in the Middle East, along with the United States, 2) political tensions exacerbated by various trade associations (including cement dealers, textile associations) condemning procedures included in the Finance Bill FY20, which they say are excessive and should be rolled back, and 3) inflationary pressures exerted by power and gas tariff hikes (becoming effective from 1st July 2019) necessitating further tightening.

Clouds of uncertainty persistent during FY19 (political transitions, shift in economic priorities, re-framing of political narrative) could disperse in FY20 where most prior actions for IMF facility are either complete or timelines are firmed-up. However, implications of tougher regulatory actions (GoP data gathering and crackdown on tax evaders) amidst the authority’s push (sometimes drastic, with judicial challenged likely) for meeting revenue targets could instill volatility in the short-term (room for supplementary amendments to plug possible revenue shortfalls. Analysts expect FY20 tax collection at Rs5 trillion as against GoP target of Rs5.5 trillion).

 

What after IMF package?

The Executive Board of International Monetary Fund (IMF) has approved a 39-month Extended Fund Facility (EFF) for Pakistan amounting to US$6 billion (SDR 4,268 million or 210% of its Pakistan quota). Along with the approval, IMF has also decided to release an upfront amount of US$ one billion in the month of July 2019 well below the country’s request of US$2.5 billion. IMF in its press release stated that the remaining amount will be disbursed evenly during the program subject to 4 quarterly and 4 semi annual reviews. Historically the IMF has followed quarterly review system.

The IMF program aims to bring Pakistan’s economy back on sustainable and balance growth. Analysts expect this may take at-least 1-2 years. The approval, according to IMF will unlock from Pakistan’s international partners around US$38 billion over the program period which is broadly in line with gross financing requirement of Pakistan. The GoP has already taken tough measures (prior actions) to secure the stated IMF program. The actions included: 1) significant rupee depreciation with implementation of market based exchange rate system, 2) hike in electricity and gas tariffs to reduce subsidy and circular debt, 3) Policy rate hike to manage inflation and 4) increasing tax revenues measures through Budget 2019-2020.

Post issuance of Letter of Intent (LOI), more specific quantitative targets, structural benchmarks and indicative targets would provide more insight into the agreed terms between IMF and Pakistan. IMF loan approval will partially restore confidence on macro-economic stability. However sluggish economic growth, further monetary tightening and aggressive tax revenue targets in the medium term may keep investors participation at bay.

Citing continued uncertainty, analysts advise investors to limit exposure to growth sectors with unreasonable multiples and follow macro themes (interest rate, exchange rate, and circular debt resolution). As such, preferred sectors remain Banks, E&Ps and selected Power stocks. Key picks remain MCB, MEBL, and BAHL (balancing power for interest rate exposure to provisioning risks), OGDC and PPL (exchange rate hedging, PPL also likely to benefit from circular debt resolution) and HUBC, NPL, NCPL, PSO (circular debt resolution and further depreciation of PKR).

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