Elixir Securities Limited – Elixir Insight

Karachi, June 27, 2018 (PPI-OT): Pakistan Equity Market – Amnesty Scheme’s Success to serve as a Boon for Domestic Liquidity

We estimate total asset declarations of PKR1.8tn, with domestic assets accounting for PKR1.2tn; bulk of the foreign assets are likely to be declared but not repatriated, being taxed at 3/5%.

Combining the projected repatriations and taxes on foreign assets, we estimate a paltry USD0.7bn foreign inflow which is unlikely to alleviate the BoP crunch.

The size of the formal economy as a percentage of total economy is estimated to reach up to 83% from 80%. This shall have a one-off positive impact on FY18 GDP growth which would be revised once the full year data is compiled and finalized.

The domestic side of the Amnesty Scheme is likely to be extremely successful; our projected PKR1.2tn worth of domestic asset declaration is 3.5% of FY18EGDP, 10% of Banking Deposits and 50% of Free Float Market Capitalization.

A major chunk of freshly declared domestic assets will continue to be tied up in the working capital of businesses, however the liquid portion will gradually be diverted from Prize Bonds, gold bars and foreign currency parked in lockers to bank deposits, equity market and mutual funds.

PKR1.8tn of Asset Declaration on Cards; with Domestic Assets Accounting for the Bulk: Based on news reports, up till June 25, 2018 Federal Board of Revenue (FBR) had collected (including commitments) PKR36bn in taxes on ongoing Amnesty Scheme. Given that it has just been a couple of weeks since the go-ahead was given by the Supreme Court (SC) on the Scheme and most people tend to file in the last few days, we estimate the tax collections (on Amnesty) to cross PKR72bn by the end of June 30, 2018 (the current deadline to avail the Amnesty). At an average rate of 4%, this implies an estimated total Asset Declarations of PKR1.8tn.

Based on our discussions with the tax lawyers (involved in the process of filing) and people availing the ongoing scheme, we are led to believe that the bulk of the declarations will likely be on Domestic Assets (undocumented so far). Assuming that two-thirds of the total assets declared will be domestic, we project an addition of PKR1.2tn to the formal/declared domestic asset base, via the ongoing Amnesty Scheme.

Foreign Asset Declarations are Unlikely to Lead to Material Flows: Based on the aforementioned assumptions, around ~USD5bn worth of foreign assets amassed by Pakistanis may be declared via the ongoing Scheme. However only a minute fraction of this may actually find its way into the country given the abysmally low differential between taxes applicable on “foreign assets declared and repatriated” (2%) vs “foreign assets declared and not repatriated” (3/5%). Combining the projected repatriations and taxes, we estimate a paltry USD0.7bn foreign inflow. In terms of Foreign Exchange Reserves, that might be a meaningful addition of 7% to the State Bank of Pakistan’s (SBP) reserves – but is unlikely to alleviate the BoP crunch as we estimate gross foreign external financing requirement of USD24.6bn for FY19 alone.

So how much is PKR1.2tn?: While foreign flows may not be too heartening, the domestic side of the Amnesty Scheme is likely to be extremely successful, as a number of Business Owners (particularly in Trade and Services) are availing the Scheme. Reduction in market premiums on Prize Bonds drawn in the raffle (traditionally being used to whiten the undocumented domestic wealth) from 8% to under 6%, lends further confidence to our assumptions. The reduction in these premiums imply trimmed appetite/demand amidst ongoing official Amnesty Scheme.

Our projection of PKR1.2tn worth of domestic asset declaration should not come as a surprise. After all, estimates suggest that out of around 3.5mn traders throughout Pakistan only 135,000 fall in the tax net. Trading sector constitutes around 19% of the GDP but traders’ tax contribution is only 0.05% implying that the sector is virtually out of the tax net.

While a bulk of PKR1.2tn may not be in cash, and will continue to be tied up in working capital of undocumented businesses – let us put the amount into perspective:

3.5% of FY18E GDP

10% of Banking Deposits

14% of Pakistan Equities Market Capitalization

50% of Pakistan Equities Free Float Market Capitalization

2x the Assets under Management in Mutual Funds

5x the Assets under Management in Equity Mutual Funds

Implications of Formalizing Grey Economy: We analyzed the impact of this amnesty scheme on formal economy as certain portion of grey economy becomes documented. Assuming size of grey economy as 25% (source: SBP Working Paper) and PKR1.2tn declaration of domestic assets, the size of formal economy as a percentage of total economy is estimated to reach up to 83% (depending on the proportion of PKR1.2tn declared domestic assets constituting production and services) from 80%. This shall have a one-off positive impact on FY18 GDP growth which would be revised once the full year data is compiled and finalized. Similarly, our assumption based estimates indicate one-off increase of up to 3.3% in GDP (depending on the proportion of PKR1.2tn declared domestic assets constituting production and services).

Another implication of this Amnesty Scheme is on one-time tax collection, estimated at PKR72bn (amounting to 0.2% of GDP and 1.8% increase in tax collection over FY17) and sustainable tax revenue stream from freshly documented businesses.

On the Expenditure front, we believe that major proportion of increase in formal economy would translate into higher documented Consumption relative to other constituents (i.e. Government Spending, Investment and Net Exports) as the latter have relatively greater level of documentation compared with Consumption.

Finally, increase in potential liquidity and size of formal economy is unlikely to result in higher inflationary pressures – as total consumption and spending in the economy may not increase significantly – it is just the change in pie of the formal vs informal economy that is likely to undergo a shift.

Recap on Amnesty Scheme 2018: Launched in Apr-18 the Amnesty Scheme allows citizens of Pakistan to disclose previously undeclared assets, at 2-5% being charged on the assets depending on factors such as asset class, domestic/foreign asset and asset repatriation (refer to enclosed table for respective slabs). The motivation behind the Scheme was to 1) shore up foreign exchange reserves eyeing repatriation of offshore assets parked by Pakistanis, 2) increase tax net, 3) document the vast grey economy of the country and 4) provide a way out for Pakistanis fearing OECD (Organization for Economic Cooperation and Development) Tax Information Treaty which is applicable from September 1, 2018. However the Scheme garnered limited traction till May end – which however picked the momentum only in June post Supreme Court’s green light to the scheme.

Capital Markets Liquidity to get a Boost: Driven by unabated foreign selling, concerns on Balance of Payment, weakness in Pak Rupee and potential deceleration in GDP growth going forward, KSE100 Index has plummeted by 22% while market capitalization has fallen by USD30bn from 2017 highs. The success of the Amnesty Scheme is unlikely to significantly alter the real issue at hand i.e. surging requirement for foreign financing needs. However it has the potential to significantly improve the domestic liquidity landscape in the country.

A major chunk of freshly declared domestic assets will continue to be tied up in the working capital of businesses, however the liquid portion will find its way into formal economy. The traditional avenues for such undocumented wealth has been the notorious Prize Bonds (bearer instruments), gold bars and foreign currency parked in lockers. These assets, once declared, will have a number of legal avenues opened up for them i.e. bank deposits (particularly in the increasing interest rate environment), equity market and mutual funds. Given that equity market valuations have already opened up to multi-year lows (forward PE has come off for 2017 high of 10.3x to 7.9x as of now; forward dividend yield has surged to over 6%) – a stream of fresh liquidity into equities may be on the cards!

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