The key risk for investors would be an inability of the Pakistan Tehreek-e-Insaf (PTI) government to deliver on promised reforms and a renewed deterioration in fundamentals, as this would exert pressure on the PKR once again, says Credit Suisse, a Swiss financial services firm.
The firm in its latest report, "Pakistan: On the path to recovery" stated that it is important to keep in mind that the government holds a thin majority as part of a coalition in the National Assembly and does not have a majority in the Senate. This adds further pressure on the ruling PTI.
Given that Pakistan shares a border with India, Iran, Afghanistan and China, geopolitical risks are also a concern, the report says. In particular, we would point to Pakistan's relations with Afghanistan, India and the USA. Pakistan also has strong business and trade linkages with China, and could see fallout from the coronavirus impact as a result, the report maintains.
It further states that one of the factors that have weighed on domestic demand has been the soaring levels of inflation, driven by the 50 percent devaluation over two years and rising food prices. There are early signs of a stabilization in headline inflation readings, though it is too early to confirm.
Nevertheless, we would expect to see base effect driven easing in inflation over the latter half of 2020, it adds. The report says, "Pakistan's fundamentals have improved significantly in the wake of the IMF assistance, fiscal consolidation, and much needed reforms.
However, significant challenges still lie ahead. [In] near term, we expect equities to remain range-bound after a strong rally, but the long-term upside potential remains significant. As the PKR has stabilized, and there is potential for further modest appreciation, we believe the carry trade offers a compelling risk/reward opportunity and recommend short duration t-bills."
It states, "The reverse repo rate has risen dramatically from its lows of 6.25 percent in December 2017 to 13.75 percent in July 2019 as the State Bank of Pakistan (SBP) fought to rein in inflation.
In doing so, the central bank also fulfilled policy actions required by the IMF. Rates have been held steady since then and we do not see further rate increases on the horizon. With inflation remaining elevated, it seems too early for a rate cut and we believe the SBP will most likely await firm signs of disinflation before doing so. In addition, real rates remain low implying limited pressure for rates to be reduced in the near term."
The report maintains that Pakistan's difficult economic situation draws strong parallels with Egypt's: years of persistent and endemic corruption; spiraling deficits that pushed an economy to the brink of default; escalating debt/GDP and declining reserves; a vastly overvalued currency; the military's over-sized role in the private sector; and a new government that promises to deliver on long-needed and difficult reforms. Even the returns on t-bills are similar, though the withholding tax of 10 percent in Pakistan (vs. 20 percent in Egypt) nets a modestly higher post-tax return for Pakistan's t-bills.
It adds, firstly, "Pakistan's economic challenges are arguably greater than Egypt's, at least to the extent that Egypt's initial steps had a more far reaching and positive impact than Pakistan's. Egypt's track record on economic crises is also less intense, with the government having accessed nine IMF programs compared to Pakistan's 22. Second, Pakistan's economic sensitivity to its exchange rate is less than Egypt's.
This can be seen clearly through tourism and exports, sectors in which Egypt excels but Pakistan is severely lacking." The report states, "With regard to tourism, the government's efforts to promote Pakistan have yielded important results, with Pakistan being listed as the top tourist destination for 2020 by Conde Nast's Traveller, among others. While this bodes well for future inflows, the industry will take time to scale up."
It maintains, "Pakistan's export industry, meanwhile, has averaged 13 percent of [the] GDP historically but languished at just 8.8 percent in 2018. This was the third lowest in the world (according to the World Bank data), after Burundi and Ethiopia, and positioned Pakistan as one of only four countries in the world with an exports/GDP ratio less than 10 percent."
The report adds, "Egypt in contrast has seen exports to GDP averaging at 20 percent historically. The poor showing reflects years of under-investment in key industries, a high concentration in a few low value added products, and weak labor productivity. Exports have also suffered due to security concerns with Afghanistan, which was Pakistan's top export partner in 2016. Pakistan's poor export competitiveness also explains why exports to China have not risen more under CPEC." maintains, "Third, Egypt benefited strongly from the discovery of a large gas field, which was a key driver behind the sharp reduction in its current account deficit. While Pakistan may well have sizable deposits of oil and gas, major discoveries have so far been elusive."
About the risk warning, the report says that every investment involves risk, especially with regard to fluctuations in value and return. If an investment is denominated in a currency other than your base currency, changes in the rate of exchange may have an adverse effect on value, price or income.
About the financial market risks, the report maintains that historical returns and financial market scenarios are no reliable indicators of future performance. It says that the price and value of investments mentioned and any income that might accrue could fall or rise or fluctuate. Past performance is not a guide to future performance.
If an investment is denominated in a currency other than your base currency, changes in the rate of exchange may have an adverse effect on value, price or income. About the alternative investments, the financial services firm's report says that hedge funds are not subject to the numerous investor protection regulations that apply to regulated authorized collective investments and hedge fund managers are largely unregulated.
It maintains the hedge funds are not limited to any particular investment discipline or trading strategy, and seek to profit in all kinds of markets by using leverage, derivatives, and complex speculative investment strategies that may increase the risk of investment loss.
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