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Politics overshadows multiple positives

Politics overshadow multiple positives

The perspective of a situation analysis matters a lot. Just as current Pakistan’s politics overshadow multiple positives. Believing that the KSE-100 index is an indicator of Pakistan’s economy, many investors, particularly those overseas follow it a little religiously. October was being watched specifically, because of the FATF decision.

The benchmark index mostly remained on an upward trajectory for most of October, hitting a high of 42,350 points, before politics dragged it to close flat for the month ( up 4% in US$ terms).

Imran Khan commenced his march onto Islamabad in a bid to galvanize public support and force early elections. However, his return to power is getting more complicated.

The rising political noise overshadowed positives such as the much-awaited exit from the FATF grey list, continued improvement in the current account, and unchanged interest rates for the second straight monetary policy.

It is possible that politics will continue to mar the sentiment in the near term.

However, the risk-reward remains highly attractive, especially across the medium term. Mobilization of support from Saudi Arabia and China and the release of a US$1.5 billion loan by the Asian Development Bank (ADB) can act as catalysts.  

Near-term checkpoints include the appointment of a new Army Chief in November this year. While the army has vowed to be apolitical, a wider berth to civilian space may only materialize gradually at best.

Pakistan-US relations remain circumspect (President Biden’s throwaway statement on the security of Pakistan’s nuclear weapons was walked back by the State Department, but it is still reflective. 

Finance Minister Ishaq Dar backtracked on the reduction in the Petroleum Levy following his meetings in Washington, showing ease in the IMF program’s conditions. All eyes are fixed on the upcoming review, most likely in November.

Dar has also dropped the plan to approach the Paris Club for debt restructuring, possibly because it may have entailed taking a haircut on commercial debt as well. With both Moody’s and Fitch downgrading Pakistan’s credit rating by a notch to Caa1 and CCC+, respectively, the government has doubled down on its efforts to win bilateral debt rollover and fresh investments.

Prime Minister Shehbaz Sharif left for China, having met the Saudi Crown Prince earlier. Success on this front can ease Balance of Payment concerns, reduce PKR volatility, and help build the case for earlier-than-anticipated interest rate cuts. The market may look beyond politics and commence rerating. Our base case remains the full repayment of maturing international Sukuk in December this year.  

Despite the intense political and economic pressure this year, the KSE-100 index is down a muted 7.5%CYTD, much lower than global equities, where analysts believe the cheap valuations already incorporate the risks.

In US dollar terms, equities are down to a sharper 26%CYTD, but currency weakness against the US dollar is global and not specific to Pakistan.

Analysts’ assessment of a favorable risk-reward is backed by strong corporate profits, up 25%YoY for 3QCY22, led by Banks, Oil Exploration, and Technology.

The impact of Inflation

Pakistan’s CPI rebounded to 26.6%YoY in October 2022, sharply up from its 23.2% in September 2022. The latest level is near the record high of 27.2% in August 2022, with the latest spike in inflation coming from the unwinding of relief from fuel tariff adjustments, topped up by quarterly adjustments in energy tariff, as well as elevated food inflation.

High perishable prices have followed the floods, where wheat prices also continue to spike in the food index. Core inflation is also maintaining its uptick, where the national core inflation now stands 1.2ppt above the policy rate.

Food inflation continues to have a major impact on headline inflation, which is up 4.7%MoM in October 2022 after increasing by a sharp 5.8%MoM in September 2022. This is primarily because perishable prices continue to remain impacted by floods. The key movers were wheat, onions, and tomatoes.

The housing index has added the most in sequential movement in inflation as the unwinding of fuel tariff adjustment relief was topped up by quarterly tariff adjustments. This lifted the Electricity index by 90%MoM, which coincided with the quarterly house rent adjustment of 1%MoM.

The only respite to sequential movement in inflation has come from the marginal decline in the POL prices, where the Transport index dropped 1.8%MoM.

Going forward, quick respite can only come from food inflation but there are challenges. Increasing wheat prices, emanating from supply-side constraints, are being exacerbated by costly wheat imports. Simultaneously, the continuing impact of floods continues to take away from the recent appreciation of PKR and administrative measures in mitigating inflationary pressures.

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