Karachi, June 13, 2022 (PPI-OT): Pakistan Budget: Budget’23 Enough to placate the IMF?

Budget’23 – Be ready for mini budgets: Ambitious in targets but lacking in substance – that’s the way to define Budget’23. In its current shape, stipulated macro targets are unlikely to be achieved. While GDP growth (5%) and fiscal deficit (4.9%) will likely miss marks, it is tax collection at PkR7.0tn that is concerning, particularly in the context of IMF where induced economic slowdown with emphasis on import slowdown may lead to policy revisions, aka mini budgets.

Tangible steps on tax collection but will they suffice? GoP’s decision to tax the untaxed is certainly laudable. Will it suffice, however, is completely a different question. A cascading tax structure on real estate profits at 15%, adjusting by 2.5% each year thereafter is certainly welcome, and brings it on par with equities (same cascading structure starting at 15%). Taxation on deemed rental income should also curb speculation, however, may face challenges in implementation. Focus on increasing tax net is evident where fixed 3-10k tax on retailers is a step in the right direction. That said, agriculture sector still eludes tax ambit.

Inflation and Petroleum levy targets are plain unrealistic: Petroleum levy has been budgeted at an unrealistic PkR750bn, which even assuming cap rate of PkR30/liter being charged, indicates the GoP forecasting oil sales growth of 25%YoY. AKD estimates FY23 diesel sales to fall by 5%YoY while mogas sales are projected to remain flat YoY. That said, PDL amount does indicate further rounds of fuel price increases. The same will manifest in high inflationary pressures where an 11.5%YoY CPI expectation by the GoP seems quite unrealistic.

Winners – Pharmas, Foods and Entertainment: Additional taxation measure on corporate profitability (income above PkR300mn to be taxed an additional 2%) is likely to be overshadowed by increasing taxation of real estate, thereby eliminating the arbitrage other asset classes have over equities. On the sectoral front, Budget’23 is clearly positive for Pharmas (elimination of CD on 30 APIs) as well as Foods (annulment of GST on wheat, maize, sunflower, canola etc. – UNITY, RMPL), Textiles (tariff rationalization on synthetic yarn, PkR40.5bn to be released under DLTL) and the Entertainment sector (5 year tax holiday to film makers, new cinemas, production houses – HUMNL). Market is neutral for the Construction sector (real estate taxation may hurt demand while 100% depreciation adjustment in 1st year is positive for expanding Cement players).

Losers – Autos and Banks: Budget’23 has negative connotations for Autos (no new vehicles for GoP employees; increased advance tax on autos above 1600cc – INDU) as well as Banks (taxation increased to 43% from previous 39% including super tax).

Abolishment of Section 62 – Mutual Funds to be impacted? The GoP has eliminated Sections 62, 62A and 63 of the income Tax Ordinance, thereby ending tax credit on investment in new shares, including IPOs and Mutual Funds, Health and Life Insurances and Voluntary Pension Schemes (VPS). This can potentially have negative repercussions for the market.

Investment Perspective: Initial euphoria in selective sectors may potentially remain short lived as reality of ‘do more’ sets in, particularly with respect to IMF’s conditions. Despite GoP’s attempt to shield the lower and working classes (lower tax rates on different slab for salaried class), incidences of higher fuel and power prices will further aggravate inflationary pressures in the days to come. Recent remittance number (May: US$2.3bn) has surprised on the lower side, despite following historical trend, where the recurring number may become crucial in the days to come. Despite current P/E at an undemanding 4.6x, an economic slowdown may necessitate further downward revision in earnings (and by default increasing P/E) where we advise investors to remain cautious and invest selectively. As stated above, preferred plays based on budgetary developments include Pharmas, Foods, Textiles and Entertainment sectors.