After undergoing its worst economic crisis in decades, Pakistan’s economy appears to have reached an inflection point with the recent breakthrough with the IMF on a new 9-month SBA (Standby Agreement), a major positive surprise. High-frequency economic indicators appear to have turned the corner as inflationary pressures, after peaking in May, are starting to decelerate, albeit from a high base. Despite stringent IMF conditionalities on energy tariff hikes, we expect inflation to continue to moderate and decline to mid-teen levels from 29.4% by early next year, paving the way for rate cuts in 2HFY24.

Forex reserves have also bottomed out and should gradually improve particularly post-IMF SBA with anticipated flows of USD 4-5 billion in July-Aug from IMF, bilateral partners, and multilateral institutions. Going forward, while we do see substantial debt repayment pressures, resumption of C/A deficit due to the easing of import controls, FX reserves should still rise to around USD 7.5 billion by Dec-23 (USD 4.45 billion currently) implying ~8 weeks of import cover. PKR has also witnessed some pullback against the greenback though we do see the PKR reverting to a more normal rate of depreciation against the USD in line with interest rate/inflation differentials.

IMF’s agreement – an excellent opportunity for economic stabilisation

We believe the IMF SBA offers an excellent opportunity for the authorities to continue the IMF led reform agenda, particularly during the transitionary period of the caretaker government. The signing of the SBA has allayed investor concerns about the uncertainty in economic policy and outlook between June 30th and the formation of the new government, particularly without an IMF program, as evidenced by the positive trends in Eurobond prices (+35%) and the significant reduction in CDS spreads (-2907bps to 38.9%), ensuring the momentum for macro stabilization and reform agenda over the next two to three quarters. More importantly, it shall provide the caretaker government with a clear framework and defined policy roadmap for economic decision making. In addition, the 9-month tenure shall also provide the incoming government a buffer period to negotiate a new long term IMF program which would be essential for broad-based and deep-rooted structural reforms.

Equities now offer the best risk-reward of all investible asset classes

We believe the equities now offer the best-risk reward over a 12-18 months horizon benefitting initially from the macro tailwinds with the long-term momentum supported by political stability and continuation of the reform process under the watchful eye of the IMF.

1) The KSE-100 PE(x) is remarkably low at 3.6x even lower when compared to countries that have defaulted or faced default concerns, including Sri Lanka, Argentina, and Turkey. Also, the KSE-100 PE is also trading at a discount of 39%, as compared to its 5-year average of 5.9x.

2) Despite the prevailing economic challenges, the KSE100 index demonstrated resilience by achieving a noteworthy profitability growth of 8.8% during 9MFY23. Looking ahead to FY24, we anticipate a continued positive trend with an expected earnings growth of 8.3%. With the healthy earnings growth and economic challenges easing off in FY24, there are promising opportunities for investors in the market.

3) The Stand-By Agreement (SBA) amounting to USD 3.0 billion with the IMF is expected to facilitate inflows from various multilateral and bilateral partners as well as friendly countries. These inflows, in turn, are anticipated to bolster the country’s foreign exchange reserves leading to increased stability in Pakistan’s external economic landscape.

4) There’s ample liquidity available in the market, thanks to the presence of local institutions and investors. An interesting trend worth noting is the growth of mutual fund Assets under Management (AUMs) from PKR 742 billion in FY20 to PKR 1,493 billion in FY23. However, the proportion of equity AUMs as a % of the total has declined from 24.0% in 2020 to 9.5% in 2023. There are strong prospects of conversion from fixed income to equities and for every 1% conversion, an estimated inflow of around PKR 15 billion is anticipated in the market.

5) Foreigner holdings in Pakistan through Special Convertible Rupee Accounts (SCRA) have reached historic lows, declining from USD 8 billion in 2017 to a mere USD 0.9 billion in 2023. However, the recently successful agreement with the IMF opens up possibilities for renewed interest and potential exposure from foreign investors.

6) Investors need to make a portfolio of few stocks that can generate much higher returns than the benchmark KSE 100 index rather than just relying on passive index portfolio returns.

(Contributed Shahid Ali Habib, Chief Executive Officer – Arif Habib Limited)