THE FUND
The fund fell 12.9% in June, compared to MSCI Pakistan IMI Net TR (SEK), which fell 14.9%. The rupee’s depreciation versus the USD of around 10% was the main reason behind the negative performance. The fund’s underweight in the Energy sector had the most important relative contribution and added about 2.5% relative return. Contributions were also received from the Real Estate sector (0.8%) and Financials (0.6%). The fund’s overweight in Consumer Staples was the single most negative contribution (-0.6%). The month was characterized by grave concerns and outflows from local funds, which explains the relatively even sectoral development where all sectors fell roughly the same. The fund’s holding in Aisha Steel Pref was sold during the month. Some rebalancing of the portfolio took place, something we will tell more about at a later stage.
MARKET
The market fell 14.9% in June, compared to MSCI FMxGCC Net TR (SEK), which fell 0.3% and MSCI EM Net TR (SEK), which rose 3.5%. An important reason behind the fall in the equity market was the weakening of the Pakistani rupee by almost 10% against the US dollar. On the last trading day of the month, the budget for the fiscal year 2020 was voted through. The budget is extremely tough with a budgeted increase in tax revenues of 35% and sharp cuts in subsidies in the Energy sector, including dramatic rises in gas and electricity prices. Previous tax reliefs for selected sectors (such as textiles and cement) have been withdrawn, which resulted in an outcry in the market. A large campaign in order to increase the number of taxpayers was initiated where Prime Minister Imran Khan personally appealed to the population to register and utilize the tax amnesty offered.
The Pakistani Tax Authority (FBR) has gained new powers. FBR can now access information on all bank accounts, and all real estate transactions above a certain size need to be transacted through the banking system. In combination with an increased information exchange with foreign banks, a far-reaching tax reform is underway with a credible objective of actually documenting the Pakistani economy. A general tax amnesty has been issued which ends a few days into July. For anyone who register assets within this deadline, somewhere between 1-6% of the declared assets will be paid. Those who do not register will be prosecuted as tax evaders with the threat of large fines and, in the worst case, several years in prison. The changes have been received with strong objections among the opposition, but also from the population and the industry. However, it seems like the current government will not budge. Documenting the economy is obviously crucial if there should be any chance of building a proper social safety network. As a comparison, it can be said that tax revenues as a percentage of GDP in Pakistan in the last fiscal year were estimated to 12-13%, compared with just below 50% in Sweden. With a population of 200m with only 2m registered taxpayers, it goes without saying there is room for improvement. Preliminary data suggests that out of 50 million bank accounts in Pakistan only about 5 million belonged to individuals and entities registered as taxpayers.
Over the next three years, Pakistan wants to increase tax to GDP from an estimated 12-13% FY19 to 17% in 2021-22, about the same as India today. Changing 70 years of habit to stay out of the tax man’s reach will not be an easy task. There is a distrust that has to be overcome, but the efforts that are made this time around are credible and will probably produce a noticeable result. The fact that the budget has been approved paves the way for the IMF to approve its support loan to Pakistan of USD 6bn, which will be added to the already announced support loans and deferred import packages from neighbouring countries (China, Saudi Arabia, United Arab Emirates and Qatar) of, so far, USD 12 billion. Traditionally, a signed agreement with the IMF means that the stock market will start a new upward trajectory. However, it remains to be seen how hurt local investors are. In principle, all subsidies for gas and electricity are eliminated by severe price increases. Only the very poorest part of the population has been spared. We will see the inflation rise further from the current just over 9% (the budget anticipates inflation of 11-13%). This probably means that we will see at least one further increase in the policy rate by 100-150 points (from the current 12.25%) during the month of July. The 5- and 10-year bond yields are currently trading at just under 14%, but might increase to about 15% in the near future.
With this background, it is however reasonable to ask the question how much more negative news the market has not already anticipated. During the financial crisis in 2008, the 10-year bond yield peaked at 16.5%, and then quickly declined in line with the slower growth rate in the economy. Outside the financial crisis, we have only had one period since 2006, where the 10-year interest rate was at current levels for more than six months. It was at the end of 2010 until mid-2011. Local investors are in shock and many people are currently disappointed at Imran Khan. However, in a recent speech, Army chief Bajwa clearly supported strong measures to stabilize the economy, which proves that the military remains on Imran Khan’s side. We believe that foreign investors will take a positive view of the reforms that are currently being implemented and we believe that the interest from foreign investors has the potential to spread outside the circle that has traditionally accepted Pakistan as an investment destination. With that being said, the market remains in a bear phase and the end game of such tends to be irrational and with great volatility. It may sound strange to say this in the middle of a crisis that can soon be equated with the downturn during the financial crisis in 2008, but the fact is that the reforms that Pakistan is currently undergoing, despite the suffering it has in the short term, will create opportunities we have actually not viewed as possible in the past. At what levels the market bottoms is at best a guess, but if Pakistan completes the policy measures for the economy that have been agreed upon, the conditions for a larger, but above all, more sustainable positive trend for Pakistan as a country are created and hopefully thus also for its stock market. An important test for Pakistan and Imran Khan is likely to be his planned meeting with Donald Trump on US soil reportedly scheduled for July. It is a good opportunity for Imran Khan to talk about Pakistan’s future plans in front of a large part of the world’s media, but given Trump’s unpredictability, it is a journey not entirely without risks as well.
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