Pakistan’s political saga took a surprising turn over the weekend as Pakistan’s President approved the dissolution of the National Assembly on the Prime Minister’s advice, analysts at KASB Research said.
Imran Khan then announced early elections, likely within the next 3 to 6 months. Most notably, the Supreme Court of Pakistan (SCP) has scheduled a hearing on the Suo Moto notice taken by the CJP over the incident. Any parliamentary actions thereafter will be subject to the court’s orders.
A credit-negative event for Pakistan’s economy:
The decision to dissolve the national assembly is likely a credit-negative event for the economy. Considerable risks to announced reforms have arisen, including fiscal reforms and planned revitalization of the energy sector. Moreover, concerns of delays in the upcoming federal budget will drive sentiments of further delays in the IMF tranche’s approval. With SBP’s reserves falling to a 15 months low level of 12.1 billion (import cover: nine weeks), risks to Pakistan’s credit outlook have greatly heightened.
The scenario is evidenced by the rising international bond yields of Pakistan securities, whose yields have surged past 16 per cent compared to 5 per cent a few months prior. Moreover, Pakistan’s CDS spreads have also crossed the 10 per cent mark, a rise of 6pps from a month prior. Month to date, foreign investors have offloaded USD 28 million worth of equities, and we expect potential outflows to gain pace in the coming weeks as the political situation unfolds.
Secondary market yields and currency likely to rise further:
We expect secondary market yields of domestic securities to face additional upside pressure as macroeconomic risks heighten. Yields were already on a sharp upwards trajectory following the rise in global commodity prices, rising risks to external accounts, and falling foreign currency reserves. Rising domestic yields will likely translate to increased lending rates. Moreover, external account imbalances amidst the commodity upcycle, coupled with expected delays in the IMF tranche, will likely keep the Pak Rupee under pressure.
Sectors dependent on policy reforms will likely underperform:
We highlight risks to sectors whose performance outlook hinged on the planned policy reforms. These risks are particularly weighted towards Pakistan’s energy sector, which is presently plagued with considerable inefficiencies. We had earlier highlighted our preference for the sector on account of the planned reforms to uplift the industry, including significant actions to curb the circular debt growth.
Key risks to the energy sector emerging:
1) Oil and Gas Exploration: The WACOG bill was introduced to alleviate the cash flow crunch of the sector originating from the sale of gas. With expected delays in the implementation of the WACOG bill, which has faced harsh criticism from the opposition, we expect the cash flow woes of the sector to continue for a sustained period.
2) Oil and Gas Marketing: The WACOG bill was also expected to alleviate the cash flow issues of the OMC sector, particularly PSO. Moreover, planned reforms to ease the circular debt, including a distribution network uplift, may also face delays, further exacerbating the industry’s cash flows.
3) Independent Power Producers: The IPPs were also expected to benefit from actions to curb the circular debt. Most notably, the sector’s collections have considerably worsened after the recent surge in global energy prices. While the government had plans to set up a Revolving Account of PKR 50bn to ensure timely clearance of overdue bills, any delays on this front will continue to keep the sector’s cash flows under pressure.
4) Refineries: The improving outlook on refineries was largely dependent on the approval of a long-term refinery policy, which was expected to attract investments of up to USD 10.0bn. We project significant delays in the policy’s approval and expect the sector to continue underperforming over the medium term.
Macroeconomic hedged sectors to fare better:
As highlighted in one of our previous reports (Pakistan Strategy – USD hedged stocks a shield against macroeconomic heads), we prefer industries capable of weathering the macroeconomic headwinds including Textiles and Technology. These industries have a relative shield against rising interest rates and currency weakness.