AKD Quotidian about — A Backdoor Case for Monetary Easing!

Karachi, May 23, 2013 (PPI-OT): Bouyed by post-election fervour and strong FPI flows (CYTD: US$283mn), the KSE-100 Index has gained 27%CYTD.

According to AKD Securities in view, part of this bullish momentum may also be attributable to emergent expectations of further monetary easing. In this regard, potential arrangement of a deferred oil payment facility from Saudi Arabia may delay re-entry into an IMF program, thereby providing SBP with space to cut interest rates particularly as inflation remains soft (ApYI3 CPI: 5.8%) and GOP growth remains sluggish.

This reasoning appears to be manifesting in the money market where the bid pattern in last week’s T-bill auction showed a marked shift towards the 12m tenor while in yesterday’s PIB auction, cut-off yields came off by -30bps on average vs. the last accepted auction in early Dec’12.

In AKD Securities views, while the central bank is likely to adopt a wait-and-see approach for now and keep rates unchanged in the upcoming Jun’13 monetary policy, emergence of clarity on foreign flows could potentially lead to modest rate cuts later on in 2HCYI3.

In such a scenario, AKD Securities believes investors could consider booking profits in Banking sector shares while building up positions in leveraged sectors such as Cements and selected Fertilizers while retaining faith with the Oil and Gas and Power sectors.

BoP concerns may alleviate: Currently, Pakistan’s import cover stands at just 3.3 months and further erosion is likely in view of IMF repayments. That said, immediate-term BoP concerns may potentially alleviate if the incoming government is successful in negotiating for a deferred oil payment facility from Saudi Arabia and/or further CSF funds are released.

In this regard, news reports indicate that Saudi Arabia may offer Pakistan a 3yr deferred oil payment package. Note that Pakistan on average imports approximately 125k bpd of crude oil (FY12) and inclusive of refined products (converted to oil equivalent), total import increases to – 375k bpd.

Based on information available in the press, an arrangement with the Kingdom to provide look bpd crude would allow Pakistan to barter as well as replace Murban crude and various other blends imported into Pakistan and processed at Southern refiner.

Provisions for providing refined products inclusive of FO however will be limited and would likely be used for barter where Pakistan’s primary FO import is based on l8Ocst (through conversion from Fujairab) whereas the Kingdom exports mainly the 3BOcst grade. Based on the above, Pakistan’s fx savings could come in between US$4.5bn to US$5bn per year totalling US$1 5bn over 3yrs.

This could reduce pressure on the PkR which intensifies when iii port cover falls below three months (depreciation rate intensifies to 1%M0M) and maintain the deprecation rate to the less than the normalized O.5%MoM by pushing back the fall in import cover to Dec’13 from previous expectations of Aug’13.

Money market view has shifted: The money market appears to have shifted its view on interest rates with a notable change in bid pattern in the last week’s T-bill auction towards the 12m tenor (-70% of bids) vs. a strong preference for 3m securities over the last three months. Similarly, in yesterdays PIB auction, cut-off yields for the benchmark 10yr tenor Came off by -30bps vs. the last accepted auction in early Dec’12 to 11.09%. Moreover, channel checks indicate that a cross-section of the money market believes interest rates could come off in the upcoming Jun’13 MPS although consensus still believes status quo will prevail in the immediate term.

Implications on KSE: In AKD Securities views, the SBP is likely to likely to adopt a wait- and-see approach for now and keep rates unchanged in Jun’13 until clarity emerges on foreign inflows. In this regard, provided the Saudi oil facility comes through (clarity only likely to emerge after PM-designate Nawaz Sharif’s visit to Saudi Arabia after he is sworn in) blended with the release of CSF and an IMF program is delayed, AKD Securities believes the SBP could potentially find space to modestly cut interest rates later on in 2HCYI3.

In such a scenario, AKD Securities believes investors could consider booking profits in Banking sector shares while building up positions in leveraged sectors such as Cements and selected Fertilizers while retaining faith with the Oil and Gas and Power sectors. Risks to this thesis emanate from any delay in securing foreign assistance which would likely compel Pakistan to reenter an IMF program.

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