Morning Call about Pakistan Strategy – Arif Habib Limited

Karachi, December 20, 2013 (PPI-OT): Better inflows = rise in PKR to result in lower CPI, stable policy rate!

After having been on a steep decline to historically low level of below USD3.0bn, Pakistan’s central bank’s (SBP’s) FX reserves have now started improving, thereby providing much-needed support to the domestic currency, Pak Rupee (PKR), against USD (now trading at PKR 105.95/USD as Arif Habib Limited pens down this note), from as low as PKR 111/USD, recently – down about 4.5% in a matter of few days.

According to Arif Habib Limited, in this regard, the total liquid FX reserves of the SBP have shot up by USD505mn to USD3.47bn against USD2.96mn last week, mainly attributable to inflows received from multilateral and bilateral sources.

IMF’s go-ahead on 2nd tranche to the tune of USD553.3mn
Another significant development for PKR took place yesterday when the IMF approved second tranche of USD553mn under its EFF for Pakistan, which earlier was caught with fear of uncertainty given incomplete quarterly criteria/conditions of the new funding. The amount should cover Dec’13 repayment portion of the IMF (USD304mn) and some portion of the repayments ahead (USD1.8bn repaid so far in FY14 out of total USD3.24bn).

Rise in PKR, lower inflation to result in status quo in MPS
Despite recovery in PKR amid materialization of some of the planned foreign flows, PKR still contains uncertainty as there is still a huge chunk left to be repaid to foreign lenders (total of ~USD6.5bn external repayments for FY14).

However, it is pertinent to note here that, since PKR 1.0 attrition against USD adds roughly PKR 60bn to foreign repayments and vice versa. So, with local currency appreciating, less amount should be required to repay, which should lead to lower gov’t borrowing and thus reduced inflationary pressures (especially with expected MoM decline in CPI of 0.4% to 10.2% in Dec’13, mainly due to decline in food inflation and stable fuel prices). The SBP therefore is expected to at least keep its policy rate unchanged at 10%, if not cut, due to appreciation in PKR and rise in USD inflows (better import covers).

Impact on Equities; Mixed
Provided, PKR sustains and keeps appreciating, Pak macros should improve ahead, as discussed above. However, as Pakistan capital market acts largely as hedge against local currency depreciation, it would be interesting to see if KSE welcomes these developments considering impacts from two angles: 1) expectedly more foreign flows to equities due to local currency appreciation and expected decline/status quo in interest rates ahead (against tight monetary policy stance of SBP amid rising CPI so far) versus 2) ensuing negative impacts, only if appreciation continues, on market heavyweights (cumulative weight ~45%) like E and Ps (direct impact on revenues due to product pricing in USD), Textiles (lower net exports though largely offset by GSP+ Status), Telecom (lower LDI revenues that are in USD), IPPs (lower return due to fixed IRR in USD), Banks (indirect impact through lower/stable interest rates amid lower inflation following local currency appreciation), mixed for Cements (coal imports vs exports) while positive for Fertilizers (only few ones), Refineries (lower crude import costs), Oil Marketing (lower LCs costs for petroleum product imports) and Pharmas (lower raw material import cost).

Stock-wise, it should positively impact, or help in offsetting some of the already incurred FX losses for Sep-Dec’13 quarter (only 0.3% PKR depreciation against 2.4% with peaks) for sectors like Oil Marketing (PSO because of huge import LCs), Fertilizers (FFBL due to raw material imports, FATIMA due to lower per mmbtu feed gas price fixed in USD), Cements (DGKC, KOHC, ACPL and FCCL – because of its favourable swaps on foreign loans).

It should be Neutral for Banks and offsetting to already recorded FX gains for Power Producers (HUBC, KAPCO, NPL and NCPL because US-Pak Inflation differential still large to provide enough cushion while recent decline in PIB yields turns high-DY stocks attractive), Telecom (PTC may be impacted due to improving local currency and reduced LDI minutes flow being reported in USD), E and Ps due to product pricing in USD (OGDC, POL with immediate impacts while PPL to feel it later due to delayed pricing basis) and Textiles (NML, NCL, though impact should be muted for this year given their timely expansions and business diversification alongside recently granted GSP+ Status).

Please refer to the earnings sensitivity table on the first page for annualized bottom-line impact of 1% appreciation in PKR against USD on Arif Habib Limited’s sample companies.

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