AKD Daily, August 20, 2013 Currency Pressures & FPI flows As expectations build behind the US Federal Reserve winding down monetary stimulus later this year the dollar index has appreciated by 2%CYTD (peaking at 6.9% since Jan’13). Within this backdrop, Pakistan’s exchange rate faces headwinds underpinned by the decline in fx reserves that has led to a second round IMF program, likely to start in Sep’13. Pressure on the PkR underscores risks of a speculative run with the SBP refrained from intervention – a preamble to which is the ~2% depreciation in the 3rd week of Jul’13. Our auto-vector regression analysis using import cover as well as inflation and interest rate differentials shows FY14 PkR/USD depreciation of 8.8%YoY to PKR107.64 by Jun’14 end (-1sd PkR102.8/+1sd PkR112.48) with weakness concentrated in the remainder of CY13. Efforts to support the PkR include an urgency to revive the privatization program (likely by CY14) and over-hauling reforms particularly for energy where the National Power Policy has set a broad outline. As a result, we believe currency risk is unlikely to impinge much on foreign interest where outlook for the PkR versus the US$ should remain relatively stable within the ambit of an IMF program over CY14 as well as increasing consensus to re-start the privatization program. Thematically, we see upstream oil & gas as a sector-wide beneficiary as well as select export oriented cements and textiles as depreciation proxy plays. A detailed report is to be released shortly. Buying Time on the External Front: Pakistan and IMF have reached a Staff-Level Agreement for a 36 month arrangement amounting to US$5.3 billion under an Extended Fund Facility (EFF) which may increase to US$6.6bn according to news reports. With Balance of Payment (BoP) risks, Pakistan’s fx reserves have come off to less than US$10.5bn (SBP component: US$5.5bn) implying an overall import cover of just ~3 months. The new program is aimed to facilitate smooth payment of the previous IMF loan’s installments (US$3.2bn due in FY14). Exchange Rate Outlook: Following the accelerated 26% PkR depreciation over 9 months in CY08, the PkR has weakened by a contained 0.4%MoM since. That said, currency weakness could gather momentum in the next few months particularly as the PkR shed 3% vs. the US$ in Jul’13. We forecast the PkR/US$ parity at 107.6 by end-Jun’14, implying FY14 currency depreciation rate of 8.8%YoY. However a speculative run is unlikely particularly within the backdrop of an additional US$5bn+ in multilateral lending and increasing consensus over restarting the privatization program. FPI Outlook and Investment Perspective: FPI flows into Pakistan have continued even within the backdrop of accelerating pressures on the PkR where stock of FII ownership is at an estimated 30% of free-float market cap and 7% of aggregate market capitalization. This underscores: 1) undemanding valuations, 2) IMF Program Stability from CY14 onwards, 3) long only bottom-up nature of Pakistan’s foreign client list and 4) depreciation pressure on the currency skewed towards the remainder of CY13. This has kept a weaker currency from negatively influencing foreign investors in our view. We believe that the concentration of depreciation risk in the remainder of CY13 and an optimistic outlook with relative stability through CY14 under an IMF program (which coupled with the release of multilateral lending and privatization proceeds could support our –ve1 sd forecast for Dec’14) undermine risk of significant outflows. That said, as expectations build behind the US Federal Reserve winding down its third round bond buying program later this year, the pace of FPI inflows is likely to slow within the backdrop of regional outflows as peer group markets trade at premiums versus mean reversion (PER/EY vs. BY). We favor index heavyweight exploration companies and export-oriented cements and textiles as depreciation proxy plays while commercial banks can rally with a tepid reversal in policy interest rates.
Posted on: Tue, 20 Aug 2013 14:45:27 +0000
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