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Karachi, September 30, 2015 (PPI-OT): Pakistan Economy: Exchange rate – Elephant in the room
Pakistan’s exchange rate has seen considerable upwards revision since last year, as the economy recovered from a meek external liquidity position, strengthening by 5% against the US$ in CY14. In Pakistan’s case, a strong PkR holds multiple implications because while the economy benefits from relatively cheaper imports (positive impact on CPI), corporations with sizable exports (such as textiles which account for (greater than) 50% of Pakistan’s exports) lose ground in terms of competitiveness.
That being said, AKD Securities Limited projects the PkR/US$ to undergo measured depreciation (avg. 2.3% p.a. in the next three years vs. 2.5% in the previous three years) as global dynamics continue to weigh and episodes of volatility can re-emerge from uncertainties over: 1) regional currency outlook, 2) US fed rate decision and 3) domestic lobbying to enhance export competitiveness.
AKD Securities Limited forecasts PkR/US$ parity to average PkR105/US$ (interbank) in FY16E (3.2%YoY depreciation). AKD Securities Limited sees comfort on equity market performance (weak historic correlation of negative 30% between index performance and PkR/US$ movements) while tailwinds from a relatively weaker PkR should benefit sectors such as Textiles (NML), Power (HUBC, KAPCO) and Oil and Gas (OGDC).
PkR Outlook – Measured Depreciation: AKD Securities Limited forecasts PkR/US$ parity to average ~105/US$ in FY16E (3.2YoY% depreciation) with annual depreciation to average 2.3% during FY16E-FY18F, escalating to 5%YoY thereafter. AKD Securities Limited derives AKD Securities Limited’s estimates based on time-series econometric regression analysis accounting for key drivers, primarily: 1) fx reserves, 2) inflation differentials and 3) interest rates.
Downward pressures can emanate from: 1) expectations of stronger US$ performance, 2) regional currency volatility and risks of competitive devaluation across the region, 3) higher debt servicing over the medium term, and 4) inflationary pressures re-emerging from next year.
While pressures for state enforced depreciation to aid trade competitiveness remain, AKD Securities Limited expects limited interference from the government where a weaker PkR can: 1) erode benefits of low oil prices (lost savings of PkR40bn in FY16E oil imports for every 1% PkR/US$ depreciation) and 2) negatively impact expected US$1bn Eurobond and Sukuk issuance in FY16 as well as planned privatizations. Additionally, AKD Securities Limited has constructed the PkR’s REER Index which also implies that the PkR is misaligned over its fundamental levels, underscoring AKD Securities Limited’s case for measured depreciation going forward.
Implications: AKD Securities Limited’s forecast of measured currency depreciation holds multiple implications for the economy and stock investors. Despite providing short term relief due to lack of coherent policies to improve trade sector development, PkR/US$ depreciation can be positive for the country’s export competitiveness.
On the flip side, a stable BoP position accompanied with a comparatively less vulnerable currency can be beneficial for the attraction and retention of foreign flows. With fx reserves and other external account indicators on a positive trend, AKD Securities Limited anticipates foreign investor interest in Pakistan to sustain.
Investment Perspective: AKD Securities Limited sees comfort on equity market performance (weak historic correlation of negative 30% between index performance and PkR/US$ movements). Moreover, companies which have US$ hedged revenue streams stand to materially benefit. In this backdrop, AKD Securities Limited believes export based sectors such as textiles should benefit as a weak PkR can help gain some lost ground on the competitiveness front.
Similarly, the energy sector (e.g. E and P and IPPs) with its US Dollar based revenue streams (combined 20% of total revenues at the KSE-100) should receive a boost from weakness in the PkR. Playing this theme, AKD Securities Limited recommends taking exposures in NML (TP: PkR167/share), HUBC (TP: PkR107/share), KAPCO (TP: PkR89/share) and OGDC (TP: PkR175/share).