Karachi, August 30, 2022 (PPI-OT): IMF program back on track – Positive for PSX

The Executive Board of IMF completed the combined seventh and eighth reviews under the Extended Fund Facility (EFF) for Pakistan, paving way for an immediate disbursement of US$1.2bn and another ~US$2.5bn by end FY23.

This includes an extension of the program by 8 months and approx. US$1bn to US$6.5bn, approving waivers of nonobservance of performance criteria. The agreed program size was close to US$6bn at the time of approval (SDR4.27bn), has slightly changed over time given movement in SDR rates/US$.

The initial press release is in line with expectations where Fund stressed on implementation of FY23 Budget, continuation of market-determined exchange rate, proactive and data-driven monetary policy and pick up in pace over SOE improvement.

The credibility for macro framework that comes alongside IMF approval could prove to be timely, as Pakistan looks to mobilize global support / investment to tackle macro challenges which have been further intensified due to recent floods.

The resumption of IMF and resultant comfort on reforms and PKR should unlock valuations at PSX, trading at 3.7x PE. We recommend cherry picking for now, where broad based rally would likely await clarity on aftermath of the floods’ damage.

Nod to release US$1.2bn and another ~US$2.5bn by FY23-end

The 7th and 8th reviews under IMF’s Extended Fund Facility (EFF) for Pakistan finally completed with the Board’s nod to disburse US$1.2bn (SDR894mn) in the coming days. The agreed program size was close to US$6bn at the time of approval (SDR4.27bn), has slightly changed over time given movement (refer to table on the right) in SDR rates/US$. The program has also been extended by another ~US$1bn (SDR720mn) to US$6.5bn (SDR4.99bn).

The extension has been agreed considering the country’s higher financing needs for FY23, where the State Bank of Pakistan (SBP) had guided regarding US$30bn debt obligations for the ongoing fiscal year, vis-à-vis external arrangements of US$37bn. Also, IMF expects the country’s total foreign exchange reserves to improve by US$6.5bn this year.

IMF program which provides a stamp of credibility to the macro framework will enable Pakistan to fund the gap via multilateral and bilateral loans as tapping international capital markets (For Euro bonds etc.) may be out of the picture for some time amid current YTMs in the range of 20% – 45%. With import cover at 1.4x, Pakistan needs at least US$8bn inflows to improve the cover to 3x. So far, in addition to US$1.1bn from IMF, Pakistan expects a total of US$5-6bn external inflows, out of which US$4bn are expected from friendly countries, in the form of cash deposits, deferred payments, stock investments, SDRs etc.

As per SBP’s guidance, Pakistan expects an additional inflow of US$4bn, spread over FY23. From the US$4bn support, US$1bn is an addition to Saudi Arabia’s ongoing oil deferred program, US$2bn is expected from Qatar and US$1bn is expected from UAE.

IMF Forward guidance in line with recent govt guidance

The press release and selected projections shared alongside read in-line with the guidelines the government and SBP have been providing for last few months. Primary balance and fiscal deficit target for FY23 remain intact at 0.2%/-4.7% of GDP, in-line with numbers shared in FY23 Budget, with 3.5% GDP growth in sight. Moreover, continued data-driven monetary policy as a proactive approach to contain inflation and external imbalances was also stressed upon, which is something we have heard SBP echo as well.

On structural reforms, the Fund reiterated reduction in losses of energy sector through scheduled increases in fuel tariffs and taxes/levies and need for reforms for SOEs. Increase in power and gas tariffs is also something the government has been progressing in, where scheduled power tariff increase has also been implemented. Related to the banking sector, the need of addressing the issues of undercapitalized financial institutions were mentioned once again.

The Fund recognized the country’s struggles over the overheated economy, coupled with aftermath effects of war in Ukraine, which led to expanding external and fiscal deficits, escalating inflation and contracting import cover. In light of the same, the Fund emphasized fiscal discipline and debt sustainability to restock reserves and recover steadiness. Continuation of market-determined exchange rate was a point of focus as well.

Projections and guidance reflect pre-floods scenario

Observing projections and the press release not mentioning the ongoing calamity in Pakistan, it is highly likely that IMF would have talks with Pakistan in the near future regarding financial aid or ease off some of the macro targets for FY23. Current projections reflect FY23 average CPI at 20% and CAD at 2.5% of GDP (~US$10bn), optimistic than our expectations of US$13bn, ~3% of GDP. This is despite IMF assuming a monthly import bill sticky at US$7bn, much higher than our estimates of US$5.2bn/month.

No negative surprises may keep the market content

External flows maintain their utmost importance in order to improve the country’s buffer in foreign exchange reserves, where smoothly sailing the 7th and 8th review is a step towards stability. This makes it time for PSX to unlock valuations, with attractive entry point of 3.7x P/E, as a good part of macro uncertainties that hurt sentiments in the past couple of months (import cover, PKR depreciation, inflation, external funding etc.) have largely been addressed.

The ongoing flash floods, however, have arisen a situation of uncertainty. Keeping gradual resolution of ongoing macro headwinds and the new situation of floods under consideration, we highlight cherry picking within restricted themes in the medium term. We believe the equity markets offer attractive upside across the bourse in the longer term.

We prefer Banks in ongoing higher interest rate scenario amid controlled credit costs with higher ROEs not yet reflected in sector multiples. UBL, BAFL and MEBL remain our top picks.

IMF’s focus on reduction in energy losses reiterates our liking for the E and P sector, with OGDC and MARI among top picks.

Though floods are likely to result in medium term challenges for the Fertilizer sector, we expect stable revenue earnings to remain intact from CY23 and beyond with recurring D/Y.

We observe the multiples reflecting anticipated downturn in earnings already priced in sectors such as Cement, Steel, Autos over lesser availability of imported raw material, rise in product prices amid cost pressures and slowdown in economic activity. We highlight clarity over macros would lead to a rebound in cyclicals, offering an outperformance stance, albeit with a higher risk.