Karachi, July 13, 2023 (PPI-OT): IMF approval received; estimates suggest challenging road ahead
IMF's Executive Board approved a 9-month Stand-By Arrangement (SBA) for Pakistan, helping Pakistan to get ~US$3bn, with the first tranche (~US$1.2bn) disbursed immediately, followed by two quarterly reviews. The board's press release reiterates factors such as FY24 Budget implementation, market-based exchange rate, appropriate monetary tightening and reforms in the energy sector as key under the Program.
While most key estimates from IMF suggest the road ahead to be challenging and would require attention from all policy makers, one of the interesting points in the macro estimates shared by IMF is continuation of inflation. The CPI trend is expected on almost the same rate as the outgoing year (FY24E:190bp MoM vs FY23: 220bp), suggesting further inflationary pressures on the cards, while the same being reflected in the upcoming interest rate trend.
We believe upcoming tranche disbursements would be highly contingent on deliverables, a delay in same emerging as a key risk to investor confidence. The progress would assist in the remaining US$2bn from IMF, also providing comfort to other potential external lenders.
While Pakistan markets have rallied around 10% (13% in US$) since announcement of Staff level agreement, it continues to trade at lucrative P/E of sub-3x, more than 50% discount from its historical mean, despite continuous corporate profitability.
US$3bn SBA approved with immediate share of US$1bn
IMF’s Executive Board approved a 9-month Stand-By Arrangement (SBA) for Pakistan last night, that would help Pakistan receive around US$3bn (SDR2.25bn, 111% of quota). The first tranche disbursement will be immediate and amount to ~US$1.2bn, followed by two quarterly reviews.
The development follows IMF Staff level agreement reached in Jun-2023 end. The approval was largely expected post recent developments including, but not limited to, continuation of monetary tightening, withdrawal of stricter import conditions, amendments in the FY24 Budget to relatively contract fiscal deficit targets and Saudi Arabia and UAE external support extensions to Pakistan announced this week.
To recall, the SBA has given the government space to execute the electoral process that is scheduled in the next four months (Oct-2023), where the last program expiring with only 8 out of 11 tranches disbursed worth ~US$4bn (remaining ~US$2.5bn) left investor concerns at peak.
Four key factors under focus reiterated
The press release issued by the Fund once highlights the need of addressing domestic and external imbalances and a framework for financial support from multilateral and bilateral partners, reiterating the 4 points below as key focuses of the program:
1) implementation of the FY24 budget, ensuring debt sustainability,
2) market-based each rate to absorb external shocks, addressing FX shortage,
3) appropriately tight monetary policy aiming slowdown of inflation pace and
4) progress on structural reforms, especially in the energy sector.
Emphasis continued on monetary tightening...
The aforementioned are factors have been previously highlighted by the Fund as well. Having said that, continuation of emphasis on appropriate tight monetary policy comes with some extent of surprise given the State Bank of Pakistan (SBP) has so far already increased the Policy Rate by 800bp in the last year, taking the Policy Rate up to 22%. To recall, most quarters of the market had expected Policy Rate to peak at 21%, making the last 100bp increase announced through an emergent Policy meeting a surprise to the markets.
May indicate inflationary measures on the cards
While current interest rates reflect positive real interest rates on a forward-looking basis, persistent focus on the same may indicate further inflationary steps to be taken in the near future. The same is also reflected in IMF’s FY24’s CPI projections that stand at 25.9%, vis-à-vis our estimates of 20% that incorporate average MoM inflation of 120bp throughout FY24. For an average CPI of 25.9%, the MoM inflation pace would need to average at 190bp. This would be only slightly lower than FY23 average MoM pace of 220bp where the year witnessed sharp PKR/US$ levies of Rs50/ltr charged on POL products during the year.
Timely delivery of essence to maintain confidence
We highlight upcoming tranche disbursements would be highly dependent on deliverables. It would be of utmost importance for all governing faces throughout the next nine months, which include the caretaker government and the new government, to continue progress on the pre-requisites of the tranche disbursements. The road ahead will be challenging and would require attention from all policy makers as IMF estimates for FY24 report a higher fiscal deficit as well.
Any delay in progress of reforms will not only be an obstacle to the remaining US$2bn to be received from IMF, but also to the potential support to be received from other external lenders, crucial to Pakistan’s current reserve levels. The same would also reflect in investor confidence. For perspective, SBP foreign exchange reserves currently stand around US$4bn. IMF’s first tranche, alongside receipts from Saudi Arabia and UAE are likely to double the SBP reserves in a couple of weeks, taking it to 9-month high levels and improving import cover from less than a month to ~1.5 months.
Pakistan still offers a sub 3x asset, Buy!
KSE100 Index is up 10% and up 13% in US$ terms since the announcement of an agreement and any consolidation notwithstanding, there is still material upside as the political and economic uncertainty including IMF program delay has derated multiples significantly. Stagnant markets despite continued earnings growth have seen P/E derate to sub 3x, which is still at more than 50% discount from its own historical mean.
We highlight energy stocks such as OGDC, PPL, SNGP and MARI would garner interest. In addition, we prefer UBL, BAFL, MEBL, HMB, BAHL and MCB as picks from the banking sector amid attractive valuations. We also prefer the Cement sector with MLCF, PIOC and KOHC among picks. Moreover, we also recommend Pharma sector amid talks on drug price increase, where we reiterate AGP among top picks.