ISLAMABAD – A depreciation of the Pakistani rupee is now a high-probabilityevent. With external debt at $93 billion or 29 per cent of the nationalGDP, I am alarmed by the significant deterioration in the State Bank ofPakistan’s hard currency reserves from $16 billion to a mere $12 billion inthe past year.
There is no time for Pakistan to issue another sovereign Eurobond as thePML-Nawaz government’s term ends in May.
As if political risk was not bad enough, Pakistan faces a higher currentaccount deficit due to CPEC-related outflows and the rise in Brent crudeprices.
A Lula win in Brazil or a López Obrador victory in Mexico could easilytrigger emerging markets contagion at a time of rising Federal Reservemonetary tightening. Trump’s tariffs against China could not have come at aworst time for Pakistan.
The IMF projects Pakistan’s current account deficit will rise to $15.7billion or 4.8 per cent of GDP. Pakistan also faces an external financingneed of $24 billion and a debt service cost $6.3 billion or 26 per cent ofexports.
It is alarming that the SBP’s hard currency reserve have fallen sosignificantly even though Islamabad has borrowed in the eurobond marketonly four months ago and has access to international commercial bankinglines.
The Achilles heel of Pakistan, as ever, is the luxury import appetite ofits elite (no shortage of Beamers and Benzis in Clifton/Defence!), its Rs90billion circular debt, its poor tax collection/GDP ratio, its inability toaccelerate export growth, its disproportionate, Prussian scale, militarybudget and the weakness (both real and induced by the deep state) of itsdemocratic institutions.
The prospect of Imran Khan’s PTI in coalition with Asif Zardari’s PPP andsmaller parties, as happened in the senate, winning the July 2018 generalelection is a nightmare for any international investor, the reason offshoremoney has been selling Pakistani equities. I was stunned to see theturnover on the Karachi stock exchange on a day I was in town last week wasa mere $27 million, less than the notional size of an average day on mytrading desk.
Pakistan is thus very vulnerable to both domestic and external financialshock in the summer and autumn of 2018. I do not remotely expect asovereign debt crisis. The IMF’s implied risk neutral sovereign probabilityof default is a mere 6.5 per cent and the credit default spread is high(but not draconian) at 342 basis points.
Yet I cannot see how Pakistan can escape a depreciation of the rupee underits central bank’s managed exchange rate regime and would not be surprisedto see the Pakistani rupee fall to 120 against the US dollar by year end2018.
This conviction has profound implications for any strategic view onPakistani equities. The Karachi index trades at 9.4 times earnings, farbelow the MSCI Asia ex-Japan valuation multiple of 13.6 times earnings.
Pakistani equities also offer a dividend yield of 5.3 and 3-year rupeebonds auctioned by the central bank yield 6.8 per cent. Yet my rupee viewwants me to position money into OGDC and Pakistan Petroleum, who benefitfrom a rise in US dollar revenues if the rupee tanks while local operatingcost decline.
Fears of a rise in the debt receivables could pressure Hub Power down toits 52-week low at 89, where I find it irresistible. Lucky Cement andUnited Bank are my other favourite blue-chips, though not at current prices.