NBP Fund Management Limited
Economy: The recovery in Pakistan’s economy has gained further traction. Led by the robust growth in manufacturing sector and uninterrupted activity in the services sector, we anticipate GDP growth of 4.3% in FY22. The rebound in economic activity is also corroborated by the strength of a variety of demand indicators such as power consumption, cement dispatches, automobile sales volume, and sales of retail fuel. However, this strong recovery in domestic demand, coupled with spike in global commodity prices, have led to a large import bill and a hefty Current Account Deficit (CAD). More specifically, Current Account Deficit (CAD) widened to USD 1.5 billion in August 2021 after clocking in at USD 800 million in the previous month. Unlike the past episodes, this time around the central bank appears inclined to better manage the mounting pressure on the Balance of Payment (BoP), emanating from widening CAD. Instead of fixation on the fixed exchange rate, the SBP has let the PKR reflect its fundamental value with more than 10% devaluation of the Pak Rupee versus US Dollar since May 2021. In addition to this, considering the pace of economic recovery, the SBP in its meeting held on September 20th, 2021 decided to raise the Policy Rate by 25 basis points to 7.25%. Based on the economic growth trajectory and higher commodity prices, we anticipate the CAD to widen to USD 9.5 billion (3% of GDP) in FY22. Despite external account pressures, the SBP’s FX reserves stand at USD 19.5 billion helped by the receipt of USD 2.7 billion from the IMF on account of SDR allocation and a cumulative inflow of USD 2.2 billion in the Roshan Digital Account (RDA).
On fiscal operation, according to revenue board, Federal Board of Revenue (FBR) has collected Rs. 1,391 billion during July-September 2021 against the target of Rs. 1,211 billion, reflecting a massive 38% growth in FBR’s tax collection on a year-on-year basis. This remarkable performance shows that the FBR is well on its way to achieve the ambitious tax collection target of Rs. 5,829 billion for FY22. On Covid-19 front, the strategy of smart & targeted lockdowns has worked well as infection ratio in the country has fallen below 3% and active cases have dropped to around 48,000. The vaccination drive has picked-up pace as 81.6 million dozes have been administered so far. Considering the recent progress, majority of population is expected to get inoculated in the next couple of months that would mitigate the risk of any significant disruption to the economic activity going forward.
Regarding the status of USD 6 billion Extended Fund Facility (EFF) programme with the International Monetary Fund (IMF), Finance Minister Shaukat Tarin on Monday assured the IMF of Pakistan’s commitment to successfully completing the upcoming review as well as Article IV consultations. Negotiations with the IMF for the sixth review of the EFF along with Article IV consultations will begin on October 4th 2021. The large currency devaluation under flexible exchange rate regime, beginning of monetary tightening cycle with a token 25 bps hike in the Policy Rate by the SBP, and recent increase in PDL ahead of negotiation shows the intent of the government for resumption of stalled IMF programme.
Stock Market: During the last few weeks, the stock market has been under severe selling pressure. Despite attractive market fundamentals, during CY21 through September 30th, the benchmark KSE 100 Index has delivered a modest 3% return. What has caused this lackluster market performance? Investors were unnerved by the developments in the neighboring Afghanistan with the hasty withdrawal of US forces; ensuing fall of the Afghan government and takeover of Kabul by Afghan Taliban. On the Balance of Payment (BoP) position, investors also seemed worried about the widening of Current Account Deficit (CAD) that clocked-in at USD 1.5 billion in August 2021 and USD 800 million in the previous month. Furthermore, the recent devaluation of the PKR versus US dollar coupled with rising industrial raw material and energy prices have ignited concerns on the corporate profitability outlook. In a bid to contain the consumption led demand pressure, the SBP’s decision to raise the Policy Rate by 0.25% in its MPC meeting held on September 20th, 2021 was also not well received by the market. According to the market talks, leveraged positions of retail investors, who received margin calls after continuous decline in certain shares accelerated the sell-off of equities during the week ending September 24th 2021.
What lies ahead for the stock market? As we see it, stock market levels are attractive entry points for investors with medium to long-term investment horizon. In our view, the market is well positioned to deliver decent double digit returns in FY22, and beyond driven by: (i) attractive market valuations as captured in the extremely attractive Price-to-Earnings (P/E) multiple of 5.9x; (ii) robust economic activity; (iii) easier financial conditions; (iv) healthy corporate profitability; and (v) abundant market liquidity.
On the economic front, the recent currency devaluation is unlikely to derail the ongoing growth momentum. More importantly, with respect to corporate profitability, due to resilient consumer demand, companies are gradually passing on the increasing input costs to maintain profit margins. In addition to this, many Index heavy sectors such as Oil & Gas Exploration, Textile Composite, and Technology & Communication are net beneficiary of currency devaluation, and other sectors such as Commercial Banks and IPPs are currency neutral. With respect to the external account, unlike the past episodes, this time around the central bank seems prepared to better manage the pressure on the Balance of Payment using exchange rate as first line of defense. Furthermore, to curb imports of luxury items, the SBP has imposed 100% cash margin requirement and the government has levied regulatory duties on non-essential imported items.
While there are some challenges, especially with respect to Pak-US relations and recognition of Taliban government by international powers; the developments in Afghanistan also offer tremendous economic opportunities for the country that can be reaped by focusing on regional connectivity, and by building long-planned trade and energy routes from Pakistan to Central Asian states.
From the fundamental perspective, the recent indiscriminate sell-off of equities has sent market valuations to the equivalent of economic crisis eras. More specifically, currently, the market is trading at an attractive forward Price-to-Earnings (P/E) multiple of 5.9x, versus 10-year average of 8.3x. On a relative basis, 16.9% Earnings Yield offered by the market coupled with a healthy 5.7% dividend yield looks appealing compared with 10-year PIB yield of 10.5%. PSX’s valuation discount to MSCI EM (Asia) has grown to over 60% compared to its historical average discount of 40%. With respect to the Policy Rate, the SBP cited that “looking ahead, in the absence of unforeseen circumstances, the MPC expects monetary policy to remain accommodative in the near term, with possible further gradual tapering of stimulus.”
The Bottom Line: In our view, stock market would take direction from the development on the resumption of the IMF programme. Given a strong investment case for the stock market, we advise investors with medium to long-term horizon to build position in the stock market through our NBP stock funds. Our funds have a long-term track record of outperforming the stock market by a good margin.
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