Pakistan is facing the worst inflationary environment in its history. The global commodity cycle post-Covid first catalysed the unabated growth in consumer prices. Then the expansionary policies provided further impetus to the growing inflationary pressures. Ultimately, the economic position weakened, so the embedded inflationary pressures became uncontrollable.
The reserves depleted at a faster pace, led by delays in IMF funding, and bilateral commitments due to economic inactions. Current reserves merely cover a month’s imports. Subsequently, the currency has depreciated significantly over the last three years. Most of the measures recommended by the IMF have been undertaken. Though, financing assurances from bilateral remain elusive. We think political certainty is very important for the economic turbulence to subside.
The recent events signal that the incumbent coalition government will likely get the mandate for another five years. A government with a 5-year mandate is important to restart the IMF program as it would lead to much-needed structural reforms.
In our view, the currency has depreciated significantly, and clarity on the stabilisation of the economic trajectory would keep movement limited from these levels. Thereby creating limited upward pressure on inflation.
The inflationary trajectory is expected to trend downwards from Jun’23. A substantial decline is expected from Feb’24 as the base effect due to several structural decisions taken in the previous year comes into play. We expect next year’s inflation to be 21.8%. Inflation for 2HFY24 would be 17.2%. Core inflation would be ~18.6%, with 2H’s core trending to ~16.3%.
We believe the interest rates will stay current until Dec’23 while inflation readings will slowly soften. Monetary easing is expected to start from 2HFY24. We see the policy rate settling at 17% by the end of FY24.
The rolling 5-year inflation-adjusted return is more than 40% negative on a calendar year and fiscal year basis. This leads us to conclude that equity markets with negative inflation-adjusted returns would outperform other asset classes when the economic risks subside.
The high inflationary environment would ultimately reflect in the bottom lines of the companies generating earnings momentum. Further, de-rating multiples is difficult from these levels as the current situation already reflects a quasi-default scenario. The earnings growth and expanding dividend profile would drive market returns if not P/E re-rating.
Courtesy- BMA Capital Management Ltd.