AKD Quotidian about — Pakistan Economy: Stronger PKR may unlock monetary easing

Karachi, March 13, 2014 (PPI-OT): In a surprising development, the PKR/US$ parity has appreciated by

6.68%MTD (7.04%CYTD) to PKR97.90/US$, a remarkable recovery last witnessed in 2001.

According to AKD Securities, this strength in the PKR has come on the back of 1) building up of FX reserves following receipt of US$1.5bn from an undisclosed friendly country, 2) steps to curb speculation (130 days limit to convert FX into PKR as well as a ban on gold imports) and 3) the GoPs decision to use FE-25 deposits of banks to finance oil imports. While there is certainly an element of sentiments taking precedence over long-term fundamentals with a case for it being too early for the SBP to adjust its policy, AKD Securities believes the central bank may find reason to cut the DR by 50bps in the Mar 1514 MPS.

Other than soft inflation, immediate concerns on the BoP front appear to have been addressed and outlook for foreign inflows is encouraging (3G auction/Eurobond issuance/privatization proceeds). In AKD Securities’ view, while the market has moved to quickly price in the recent PKR strength, AKD Securities believes it has yet to incorporate a potential DR cut. AKD Securities recommends a shift away from Banks into leveraged sectors (Cements and selected Fertilizers) as well as high D/Y plays.

PKR strength: Further clarity has emerged on the reasons behind recent PKR appreciation vs. the US$ (6.68%MTD/7.04%CYTD) where the key reason behind the sharp US$2bn buildup in total FX reserves over the last month to US$9.5bn is receipt of US$1.5bn in the Pakistan Development Fund. Furthermore, the GoP has taken steps to curb speculation (130 days limit to convert FX into PkR as well as a ban on gold imports) and has also used FE-25 deposits of banks to finance oil imports. AKD Securities expects the currency to stabilize at ~PKR100/US$ by Jun14 where outlook for foreign flows is encouraging. Specifically, these include an IMF tranche of US$550mn in Mar14, 3G auction scheduled for Apr14, a possible Eurobond issuance and likelihood that privatization proceeds will materialize in 1HFY15.

DR cuts may be on the cards: CPI remains benign with 8MFY14 CPI average of 8.6%YoY and Core CPI average of 8.3%YoY implying +ve real interest rate of ~1.5%. Together with tangible signs that BoP concerns are being addressed with build-up of FX reserves (currently at US$9.5bn) and continuing fiscal reforms (8MFY14 fiscal deficit of 3.1% of GDP), AKD Securities believes the SBP may find room to cut the DR by 50 bps to 9.5% in the Mar 1514 MPS. In this regard, while there is certainly an element of sentiments taking precedence over long-term fundamentals with a case for it being too soon for the SBP to adjust its policy, AKD Securities believes the SBP may opt for a proactive stance.

Investment perspective: In AKD Securities’ view, while the market has moved to quickly price in the recent PKR strength, AKD Securities believes it has yet to incorporate a potential DR cut. From an asset allocation perspective, AKD Securities recommends a tactical shift where investors could consider booking profits in Banking sector shares while building positions in leveraged sectors such as Cements (preferred pick: DGKC) and selected Fertilizers (EFERT/ENGRO). At the same time, high D/Y plays (FFC, FFBL, HUBC, KAPCO, POL) may also come into the limelight.

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