What next for Pakistan shares and the rupee?
The five years until early 2015 was the golden age in Pakistani equities, whose value tripled for US dollar investors. Nawaz Sharif ’s election, the Pakistan Army’s successful campaign against terrorists in North Waziristan, the $6.7 billion IMF bailout loans, fall in inflation/interest rates and hugely successful sovereign eurobond new issues led to a secular bull market. However, Pakistan equities have since tanked by 25 per cent (US dollar terms) as emerging markets were leprosy in 2015, the rupee swooned to 105 and the Pakistani banking system faced a funding squeeze. Valuation is never a sufficient or necessary reason to go punting on the River Lyari (this river is, sadly, neither the Isis nor the Cam), never timing tool. Yet the Karachi stock exchange index trades at 8.4 times earnings, 1.4 times price to book value and a stellar 7.2 per cent dividend yield. The caveat is banks are 40 per cent of the index. Time to go long Pakistan? Not yet.
The IMF bailout pressured Islamabad to slash government spending in a bid to reduce its twin deficits. Government spending is 20 per cent of the Pakistani GDP and dwarfs banks credit in the output mix. So when Islamabad tilts to fiscal austerity, the contraction in economic growth and the money supply is as immediate as it is brutal. This is what happened in 2015. Pakistan faced a liquidity shock in its money markets. I fear 2016 will be no different.
The Pakistani budget deficit is still 5.2 per cent, far short of the IMF letter of intent target of 3.7 per cent (excluding grants) by mid 2017. This means the bearish sentiment on the stock exchange and the rupee will continue in 2016 as fiscal austerity, a deteriorating balance of payment and decelerating M2 money supply growth take their toll.
I thought the crash in oil prices and the narrowing of the current account deficit alone would trigger a bull run in Pakistan in summer 2015. I was wrong. I should have gone to my birthplace in the city by the Arabian Sea, my city of ghosts. I should have visited my grade school chums who are now Pakistan’s top industrialist and stock brokers. I did not. Woulda shoulda coulda. I was too busy shorting the Canadian dollar and loonie bashing in the currency Grand Prix. I was too busy shorting Brazil, Russia, China and India’s meltdown.
Sure, the current account deficit narrowed but non oil imports still rose. Pakistan’s elite simply imports too many luxury goods and pays minimal taxes, like the noblesse of Bourbon France. Pakistani exports contracted in 2015 as the Chinese hard landing and the slump in world trade hit. So the $7 billion crude oil windfall was, sadly, wasted. What is the endgame of Pakistan’s luxury addiction, colossal, off book military budget, dismal tax/GDP ratio, vastly extravagant consumption (the midnights children of Pakistan opted for an elitist “rentier” state model, thanks to US, Chinese and Saudi foreign aid) metrics? A significant devaluation of the Pakistani rupee.
Pakistan’s remittance windfall will also be a victim of the GCC’s $500 billion deflation shock after the oil crash. Even a $2 billion fall in remittances, trashes the rupee. Pakistan is also far too dependent on US military aid, IMF bailout funds and grants from China, Saudi Arabia and the UAE. A world where Saudi Arabia can be downgraded by Standard and Poors to only A- is not a world that will be kind to a single B credit from South Asia that resembles Bismarck’s Prussia in the army with a country department. Not when Washington is retreating into its post Obama “isolationist” mode. I cannot see Pakistan’s foreign reserves rising to $25 billion. Au contraire, I expect foreign reserves will fall in the next twelve months. This will force the State Bank to absorb excess rupees and tighten money market liquidity, a negative for stock prices.
Pakistani banks hoard excess cash in long duration government bonds at 10 per cent, not grow corporate loans.