AKD Securities Limited Equity Research – Daily Report

Karachi, June 12, 2018 (PPI-OT): Pak Economy: Widening Gap steering towards a bailout program

Exhausting external financing resources can lead to an IMF bailout program against a rising external financing gap, in our view. In this regard, a sizable current account deficit (FY19F: US$16.3bn) accompanied by chunky debt repayments (FY19F: US$7.5bn) are together expected to push gross external financing gap to US$20.7bn for the next year (average US$19.5bn in FY19-20). Consequently, untimely materialization of adequate inflows or a lack thereof can further strain FX reserves (SBP FX reserves down by US$6.1bn in FY18TD to reach an import cover of 2.23 months) where we estimate SBP FX reserves can shrink to Less than 1 month of import cover by FY19-end in such a scenario. Approaching the IMF for a financing facility through either its External Fund Facility (EFF) or Stand-By Arrangement (SBA) remains a plausible option (adequate quota available under both facilities), in our view. Encouragingly, the program should immediately focus on stabilization measures and structural reforms. Post a financing facility, currency devaluation is likely to be limited (also in line with historical trend) as REER has also declined to 111x (excluding yesterday’s devaluation move) from 125x in Nov’17, likely near its equilibrium levels. However, a delay in materialization of a financing facility can keep the currency under pressure where market forces pushing the PkR beyond our estimated currency parity of PkR124/US$ during FY19F cannot be ruled out.

Widening Financing Gap: On account of a sharp rise in CAD (up 51%YoY in 9MFY18) along with lack of materialization of adequate inflows have led to a sharp drawdown in FX reserves (SBP FX reserves down by US$6.1bn in FY18TD) during the outgoing year. In this regard, gross external financing gap stood at US$13.3bn in 9MFY18 (vs. US$16.3bn in FY17) as the GoP scrambles to utilize short term commercial borrowing to shore up reserves. We estimate gross external financing gap to likely rise to US$20.7bn by FY19F-end (vs. IMF projection at US$26.9 inclusive of short term borrowing) due to a heightened CAD (FY19F: US$16.2bn) accompanied by sizable debt repayments estimated to be US$7.5bn (including US$1.0bn Eurodollar bond and US$0.4bn repayment to IMF) in FY19F. On the other hand, inadequate external resources estimated to be US$14.25bn (ex. a financing facility) should translate into a net financing gap of US$6.4bn (though private sector borrowing and short term commercial borrowing remains a swing factor) in FY19F. Untimely materialization of adequate inflows or a lack thereof can further strain FX reserves (SBP FX reserves down by US$6.1bn in FY18TD to reach an import cover of 2.23 months) where we estimate SBP FX reserves can shrink to Less than 1 month of import cover by FY19-end in such a scenario.

IMF Program: For developing markets in economic crisis primarily related to BoP pressures, IMF provides different financing facilities to provide sufficient cushion to FX reserves and implement policies to restore economic stability. In this regard, two primary facilities are available namely: Stand by arrangements (SBA) which is short term in nature with repayments over 3-5yrs as well as accompanying fewer conditions and the Extended fund facility (EFF), a relatively longer duration (4-10yrs in repayments) facility with more focus on structural adjustments. Both facilities allow access to cumulative 435% of the available quotas with disbursement limited to 145% of quota in a single year. In the last concluded IMF EFF program (initiated on Sep’13), Pakistan utilized 216% of its quota (available quota stands at 2,031 SDR) whereas, additional 219% of quota (translating into 4.4bn SDR or US$6.3bn) is available to be withdrawn under any of the facility (limited to withdrawal of US$4.2bn in a single year). However, every IMF program is designed on case to case basis and is subject to an agreement between the IMF board and the country availing the facility.

Post Bailout: With the external account being a focal concern, a bailout program can help improve market sentiments along with a likely reversal of recent foreign sell-off. Encouragingly, the program should immediately focus on stabilization measures and structural reforms including fiscal federalism (likely amendments to NFC award), fiscal disciple (withdrawal of subsidies and rationalization of circular debt), reforming the trade regime and focus on privatization of SOEs. Post a financing facility, currency devaluation is likely to be limited (also in line with historical trend) as REER has also declined to 111x (excluding yesterday’s devaluation move) from 125x in Nov’17, likely near its equilibrium levels. However, a delay in materialization of a financing facility can keep the currency under pressure where market forces pushing the PkR beyond our estimated currency parity of PkR124/US$ during FY19F cannot be ruled out.

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AKD Securities Limited Equity Research – Daily Report

Karachi, June 12, 2018 (PPI-OT): Pak Economy: Widening Gap steering towards a bailout program

Exhausting external financing resources can lead to an IMF bailout program against a rising external financing gap, in our view. In this regard, a sizable current account deficit (FY19F: US$16.3bn) accompanied by chunky debt repayments (FY19F: US$7.5bn) are together expected to push gross external financing gap to US$20.7bn for the next year (average US$19.5bn in FY19-20). Consequently, untimely materialization of adequate inflows or a lack thereof can further strain FX reserves (SBP FX reserves down by US$6.1bn in FY18TD to reach an import cover of 2.23 months) where we estimate SBP FX reserves can shrink to Less than 1 month of import cover by FY19-end in such a scenario. Approaching the IMF for a financing facility through either its External Fund Facility (EFF) or Stand-By Arrangement (SBA) remains a plausible option (adequate quota available under both facilities), in our view. Encouragingly, the program should immediately focus on stabilization measures and structural reforms. Post a financing facility, currency devaluation is likely to be limited (also in line with historical trend) as REER has also declined to 111x (excluding yesterday’s devaluation move) from 125x in Nov’17, likely near its equilibrium levels. However, a delay in materialization of a financing facility can keep the currency under pressure where market forces pushing the PkR beyond our estimated currency parity of PkR124/US$ during FY19F cannot be ruled out.

Widening Financing Gap: On account of a sharp rise in CAD (up 51%YoY in 9MFY18) along with lack of materialization of adequate inflows have led to a sharp drawdown in FX reserves (SBP FX reserves down by US$6.1bn in FY18TD) during the outgoing year. In this regard, gross external financing gap stood at US$13.3bn in 9MFY18 (vs. US$16.3bn in FY17) as the GoP scrambles to utilize short term commercial borrowing to shore up reserves. We estimate gross external financing gap to likely rise to US$20.7bn by FY19F-end (vs. IMF projection at US$26.9 inclusive of short term borrowing) due to a heightened CAD (FY19F: US$16.2bn) accompanied by sizable debt repayments estimated to be US$7.5bn (including US$1.0bn Eurodollar bond and US$0.4bn repayment to IMF) in FY19F. On the other hand, inadequate external resources estimated to be US$14.25bn (ex. a financing facility) should translate into a net financing gap of US$6.4bn (though private sector borrowing and short term commercial borrowing remains a swing factor) in FY19F. Untimely materialization of adequate inflows or a lack thereof can further strain FX reserves (SBP FX reserves down by US$6.1bn in FY18TD to reach an import cover of 2.23 months) where we estimate SBP FX reserves can shrink to Less than 1 month of import cover by FY19-end in such a scenario.

IMF Program: For developing markets in economic crisis primarily related to BoP pressures, IMF provides different financing facilities to provide sufficient cushion to FX reserves and implement policies to restore economic stability. In this regard, two primary facilities are available namely: Stand by arrangements (SBA) which is short term in nature with repayments over 3-5yrs as well as accompanying fewer conditions and the Extended fund facility (EFF), a relatively longer duration (4-10yrs in repayments) facility with more focus on structural adjustments. Both facilities allow access to cumulative 435% of the available quotas with disbursement limited to 145% of quota in a single year. In the last concluded IMF EFF program (initiated on Sep’13), Pakistan utilized 216% of its quota (available quota stands at 2,031 SDR) whereas, additional 219% of quota (translating into 4.4bn SDR or US$6.3bn) is available to be withdrawn under any of the facility (limited to withdrawal of US$4.2bn in a single year). However, every IMF program is designed on case to case basis and is subject to an agreement between the IMF board and the country availing the facility.

Post Bailout: With the external account being a focal concern, a bailout program can help improve market sentiments along with a likely reversal of recent foreign sell-off. Encouragingly, the program should immediately focus on stabilization measures and structural reforms including fiscal federalism (likely amendments to NFC award), fiscal disciple (withdrawal of subsidies and rationalization of circular debt), reforming the trade regime and focus on privatization of SOEs. Post a financing facility, currency devaluation is likely to be limited (also in line with historical trend) as REER has also declined to 111x (excluding yesterday’s devaluation move) from 125x in Nov’17, likely near its equilibrium levels. However, a delay in materialization of a financing facility can keep the currency under pressure where market forces pushing the PkR beyond our estimated currency parity of PkR124/US$ during FY19F cannot be ruled out.

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