NBP Fund Management Limited
The economic recovery underway since the start of FY21 continues, as reflected in most high-frequency indicators of domestic demand – including automobile sales, POL (petroleum, oil and lubricants) sales, and electricity generation – as well as the strength of imports and tax revenues. The boom in commodity prices post opening up of global economies amidst ample liquidity, however, has brought Pakistan’s external account under pressure. Thus economy is now on the path of stabilization due to painful yet necessary policy measures undertaken by the incumbent government required for the continuation of the IMF program. Pakistan’s economy staged a V-shaped recovery and posted a 3.9% growth in FY2021 and we anticipate an accelerated 4.3% growth in FY2022 driven by falling Covid-19 cases, un-interrupted service sector activity, and pent-up demand in some sectors of the economy.
Inflation & Interest rate: Inflation numbers have overshot the market consensus where the CPI has jumped to double digits, clocking in at 12.3% for the month of Dec-2021. During CY22, we project inflation to remain elevated in the first half of CY22, driven by removal of subsidies in mini budget, upward adjustments in utility prices, and increase in commodity prices in international markets. However, we estimate inflation to fall sharply in second half of the year. For FY22, we expect inflation to average around 11.2%. As a consequence, we expect interest rates to increase by around 50-100bps in first half of CY22, with stable to falling interest rates (especially if commodities ease) in second half of the year.
External account: The consequence of the robust recovery in domestic demand amidst sharp surge in global commodity prices has been hefty increase in the import bill. Though the exports have also rebounded, there are rising concerns on the Balance of Payment (BoP) position since Pakistan’s imports considerably outweigh the exports. The current account deficit (CAD) remains the Achille’s heel of the economy, that has risen sharply to USD 7.1 billion during 5MFY22, compared with a current account surplus of USD 1.9 billion during the same period last year. This time around, however, the policymakers seem inclined to better navigate the pressure on the Balance of Payment (BoP) position. The recently enacted policy actions such as large currency devaluation, broadening of the scope of 100% cash margin requirement on imports, temporarily banning / levying of regulatory duties on non-essential imported items, and tapering of monetary stimulus by the SBP are expected to contain the import bill going forward. The central bank is also geared to contain the domestic demand, as the Cash Reserve Requirement (CRR) of the banking industry has been raised from 5% to 6% to curtail the money supply. We expect the CAD to increase to USD 13.5 billion for FY2022 due to pick-up in economy and increased commodity prices in international markets. Foreign exchange reserves of SBP improved from USD 13.4 billion at CY20 end to around USD 17.9 billion at CY21 end on the back of flows from multilateral agencies such as ADB & World Bank and Kingdom of Saudi Arabia. We expect FX reserves to remain stable due to expected resumption of IMF Program which will make available 750 million in Special Drawing Rights (equivalent to USD 1,059 million), and the planned issuance of International Bonds in the first half of CY22.
Foreign Exchange Market: In the foreign exchange market, PKR suffered a further 10.6% devaluation versus the US Dollar in CY21. Resultantly, it is now slightly below its equilibrium value as measured by Real Effective Exchange Rate (REER) with latest reading of 95.6, indicating a low risk of substantial devaluation. Going forward, with the PKR now near its equilibrium value as measured by REER and widening external account position, we expect a measured 7%-8% devaluation against the US Dollar during CY22.
Bond Market: During CY21, yields on fixed income avenues remained stable till the last quarter of CY21. Last quarter was volatile as yields responded to the rise in inflation and import bill. The Rupee came under pressure and State Bank of Pakistan responded by 250bps rate hike in the last quarter. Before the announcement of the last MPC of CY21, yields across all tenors had risen significantly in anticipation of major hike in policy rate. After the announcement of MPC on December 14, 2021 and subsequent OMOs by SBP, yields on different tenors dropped by around 50bps. Overall, yield on 6-month T-Bill & 1-year T-Bill increased by 277bps & 251bps to 10.76% & 11.24% respectively and yield on the 5-year & 10-year PIB hiked by 136 bps & 109 bps respectively to 11.31% & 11.54% respectively during the last quarter of CY21. Average inflation for FY22 is expected to be around 11.2% and we expect around 50-100 bps further buildup in SBP policy rate in first half of CY22. Owing to the shrinking fiscal space and adamant inflation, we expect the market yields to increase and peak out somewhere in the middle of CY22. At that point, investing in long term fixed return bonds and increasing the duration of the portfolio will be recommended.
Stock market: During CY21, the stock market remained range bound and posted a 1.9% return, bottoming at 42,780 points in march and peaking at 48,726 in mid of June. The market remained range bound as it oscillated between bottom-up bulls and top-down bears. Given the mounting challenges on the economic front in the form of elevated current account deficit (CAD) & inflationary pressure due to commodity upcycle and higher aggregate demand, we highlight that government and central bank have been very proactive this time around to bring stability and preserve growth. The passing of the mini budget, which aims to collect additional revenues/remove subsidies of around Rs350bn, will also address fiscal concerns but will keep inflation in double digits. The revival of EFF facility with the IMF will not only allow resumption of multilateral flows of IFIs, easing pressure on the BoP, it will also bring discipline on part of the government towards macroprudential measures.
From the fundamental perspective, the market is trading at an attractive forward Price-to-Earnings (P/E) multiple of 5.7x versus 10-year average of 8.4x. On a relative basis, 17.5% Earnings Yield offered by the market coupled with a healthy 6% dividend yield looks appealing compared with 10-year PIB yield of 11.62%.
In the charts below, we have also provided trend of regional Price-to-Earnings (PE) ratio. It can be seen that over the years, the PE of PSX has been on a decline especially after touching high of 11.4x in May 2017. At that time, regional markets traded at 29% premium (14.7x) to Pakistan. This premium over the years has expanded and currently stands at 270% (PE of Pakistan at financial crisis level of 5.3x vs regional PE of 19.7x)! We strongly believe that this premium is expected to narrow in coming years as local participation is slated to increase with increasing documentation of the economy and foreign selling is expected to ease or even reverse from next calendar year. The channeling of liquidity towards the market should materialize next year, resulting in improvement in PE of Pakistan market.
To conclude, We expect the stock market to post around 20% return during CY22 driven by attractive valuations and double digit corporate profitability growth. we advise investors with medium to long-term investment horizon to build position in the stock market through our NBP stock funds.
Disclaimer: This publication is for informational purposes only and nothing herein should be construed as a solicitation, recommendation or an offer to buy or sell any fund. All investments in mutual funds are subject to market risks. The price of units may go up as well as down. Past performance is not necessarily indicative of future results. Please read the Offering Documents to understand the investment policies and the risks involved. NBP Funds or any of its sales representative cannot guarantee preservation – protection of capital and – or expected returns – profit on investments.