Worsening current account leading to a BOP Quagmire
Pakistan has faced a steadily worsening current account over the last five years starting FY14, whereby the CAD deficit stood at USD3.13bn, which has ballooned to USD15.96bn in the 11MFY18 (CAD to GDP at 5.36% - highest level in the last 9 years). This deficit is explained by 1) a drop in the country’s export of goods from USD24.09bn in FY15 to USD22.78bn in the 11MFY18, 2) sharp rise in import of goods which have surged from USD48.45bn seen in FY13 to USD60.15bn in 11MFY18 and 3) slowing pace of growth in remittances in FY15 & FY16 to a declining trend observed since FY16 whereby the remittances tally stood at USD19.92bn which later shrunk to USD18.03bn in 11MFY18.
This economic reality is adequately depicted in our official liquid reserves stockpile (held with SBP) which peaked at USD18.19bn in end FY16 to a recent low of USD9.66bn (as at 22nd June, 2018). The steady decline in FX reserves has also reflected in the PKR/USD parity which has seen an all-time low of 121.50 in the interbank market. This translates into a decline of 15.12% in value against the Greenback since early Dec’17 levels of PKR105.54.
Equity Market Outlook: Time to Tighten Belts
We expect a combination of higher interest rates, weaker currency, cost pressures due to an inflationary wave and most importantly a slowing growth trajectory does not bode well for the equity market. We expect further downside in cyclical sectors such as Automobiles (weaker PKR, higher interest rates, softer consumption appetite and increased competition will dent earnings) and Cements (increased capacity, expensive inputs, higher debt servicing cost and lack of pricing power will play down on overall profitability).
The defensive sectors such as Fertilizer and Power may continue to offer decent yields however any changes in policy regarding gas pricing, delay in settlement of circular debt (relevant for the power sector) will keep a lid on stock price performance. Banking on the whole is likely to benefit in the medium term as the GoP reverts to LT borrowing instruments and as interest rates start inching up, hence creating NIM expansion, however we maintain our preference in large cap banks as mid-tier players may experience the NPL’s stock to surge in a high interest rate environment. Lastly the E&P sector also makes it to our recommendation’s list upon its currency hedge and a relatively stable high oil price environment.
Based on pure fundamentals and our assumptions on the economic front, we do not expect the equity market to resurge with its full colors anytime soon, however successful conclusion of the general elections can create a relief rally which can be sustained with excess liquidity in the system. As a conclusion we believe clarity on the economic policy front which is expected in the next six months will play a lead role in deciding the future direction of the PSX, with a strong likelihood to a dull close (from a returns perspective) to the ongoing calendar year.