THE FUND:

Vote for change! PTI’s winning mantra in the Pakistan Election 2018.

During the month, the fund fell by 1.7% as compared to the benchmark’s MSCI Pakistan Net (SEK)’s return of -0.6%. Pakistan’s broader Index almost touched a new near-term bottom, only to reverse sharply as the uncertainty over election results ended and hope for structural reforms ignited interest in a newer class of investors.

In July, we decreased exposure in the Utility sector, owing to increased regulatory risks as the new government is sworn in, and in Consumer Staples where we saw mature valuations in one of our previous bets, Fauji Foods Ltd. News of a foreign strategic partner have led to strong run-up in the share prices, which in the short run, priced in most of the fundamental upside until greater clarity over the deal emerges. On the other hand, the fund increased exposure in the Materials and Financial sectors as a result of a relatively modest demand enabling price increases to pass on cost pressures and very
attractive valuations of blue-chip banks. The fund also diverted some alpha-gains from a strong overweight in the Information Technology sector into Consumer Staples, Materials and Financials.

THE MARKET:

For a country, that has been marred by friction between democratic and military forces since independence in 1947, a second democratic transition of power on 25 July 2018 was an important achievement. Investors, apart from being strong number-crunchers, place enormous emphasis on “regime stability” before venturing into Emerging Markets, such as Pakistan. If history is any guide, investors have had a clear understanding of what to expect in a military regime or under democratic rule led by either Nawaz Sharif’s Pakistan Muslim League-N (PML-N) or Asif Zardari’s Pakistan People’s Party (PPP). For a third force to emerge – Imran Khan’s Pakistan Tehreek-e-Insaaf (Movement for Justice – PTI) – is very different.

Former Prime Minister, Nawaz Sharif’s, trial concluded with him, along with Marya Nawaz, his heir-apparent, sentenced to jail for 10 and 7 years, respectively. The duo obeyed the decision anticipating a victory in the general elections and the advent of a legal framework commuting their prison terms sooner rather than later. However, the defection of “electables” from PML-N into the folds of PTI, either willingly or forcibly as rivals claim, signaled a strong chance that PTI would emerge as the largest party. In an unexpected development, the total tally of seats secured by PTI is marginally below the simple majority required to form the government but the party has already received electoral support from smaller coalition partners. Having such a strong mandate enables Oxford-education Imran Khan, Prime Minister designate, to implement a reformist agenda he has espoused during PTI’s 22-year political struggle.

Post-elections the KSE-100 Index jumped 3.3% fueled by optimism in a strong electoral mandate. Meanwhile, opposition parties unanimously cried foul but agreed not to boycott national elections, as we go to print. PPP’s leadership remains somber as it fought hard to retain its control over Sindh, Pakistan’s second most populous province after Punjab. Meanwhile, PTI appears ready to form a government in the centre, in Punjab (formerly PML-N’s stronghold), and has retained control in Khyber-Pakhtun-Khwa (KPK).

Key economic decisions taken in July were a 100bps hike in the Discount Rate as the Current Account Deficit clocked in at 5.7% of GDP in FY18. The Pakistani Rupee declined 6-7% only to erase the losses immediately after tentative election results started pouring in. Welcoming Imran Khan, P.M. designate, China agreed to loan $2bn, the Islamic Development Bank activated a $4.5bn credit facility for oil imports, and Saudi Arabia lent $1bn. On the other hand, a dampening statement from Mike Pompeo, the U.S. Secretary of State, implied the use of diplomatic pressure to ensure the IMF does not lend dollars that might be used for onward payments to China. We await clarity on the conditionalities being placed by the IMF, as the new cabinet is sworn in, and in all likelihood, formally requests the IMF for a stand-by facility. Finance Minister designate, Asad Umar, has categorically stated that no compromise on “national security” would be entertained as the China Pakistan Economic Corridor (CPEC) under the Belt and Road Initiative (BRI) remains a cornerstone of Pakistan’s political framework.

Election 2018:
Post-elections Pakistan feels optimistic. But what should we expect or rather what claims does PTI make as part of its economic manifesto? In broad brushstrokes Imran Khan’s new government places strong emphasis on core structural improvements in Pakistan’s governance system that historically has oscillated between PPP, PML-N and military coups. His agenda entails: “protecting tax-payers’ money,” controlling lavish expenditures incurred by government employees and politicians, strengthening accountability courts, enabling independent tax collection agencies to pursue tax evaders without fear of political interference, initiating accountability from the top, and investing in Human Development i.e. health and education.

Primary policy tools laid out in Asad Umar’s (incumbent Finance Minister) economic policy puts job creation at the top through facilitating private sector investors. Notably, conventionally successful industries that have had positive effects on employment are construction, manufacturing, tourism and Small Medium Enterprises (SMEs). While granular details are not available until a Cabinet is formed and the first 100 days plan is articulated, it is believed that a low-cost housing scheme and an immediate reduction in electricity-gas tariffs to match regionally competitive rates are very much in the offing. Other agenda items include plugging corruption, reducing indirect taxes, releasing refunds of exports, offering tax incentives on new investment, and revamping agriculture and livestock stocks as key measures to enhance economic growth, and potential, of the country.

The hopes pinned on the new government are unrealistically high. Especially, when tasked with running a government for the first time, mistakes whether unforeseen or anticipated are bound to occur. For the Pakistani diaspora, if even half the expectations are met, it may prove to be a long-term catalyst to take the GDP/capita from $1600 to $3500 within a decade. Exactly, how much of this economic and reform agenda will be actualised remains unclear especially when the orthodox combined opposition is bound to make life difficult for members of treasury benches. But there is still an air of optimism. We recommend that investors patiently monitor, but preferably, let us monitor on their behalf, qualitative signs of improvement in governance and corruption, and investments in human development indicators e.g. health and education to see whether the market re-rates itself and graduates from a “fiscally vulnerable Emerging Market” to the likes of high teen P/E ratios seen in developing markets. In the 2018 election, Pakistan voted overwhelmingly for “change.” Now let us see if the pace of change meets investor expectations or not.

DISCLAIMER:
Capital invested in a fund may either increase or decrease in value and it is not certain that you be able to recover all of your investment. Historical return is no guarantee of future return. The state of the origin of the Fund is Sweden. This document may only be distributed in or from Switzerland to qualified investors within the meaning of Art. 10 Para. 3,3bis and 3ter CISA. The representative in Switzerland is ACOLIN Fund Service AG, Affolternstrasse 56, CH-8050 Zurich, whilst the Paying Agent is Bank Vontobel Ltd, Gotthardstrasse 43, CH-8002 Zurich. The Basic documents of the fund as well as the annual report may be obtained free of charge at the registered office of the Swiss Representative.