By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
George Soros once observed, “the big money in emerging markets is made when things go from Godawful to just plain awful”. So true. The point of maximum pessimism in an emerging market is often an opportune moment to accumulate its shares, ideally after a political, economic or financial systemic shock. I sold my entire Pakistan equities portfolio in summer of 2017 after the Supreme Court and the Praetorian powerbrokers in the Rawalpindi GHQ (“Prussia not a country with an army but an army with a country”, the French philosopher Voltaire once observed – and he died almost two centuries before the birth of the Land of the Pure on August 14, 1947!) sacked thrice elected Prime Minister Nawaz Sharif for his fondness for Mayfair luxury flats bought via Panamanian shell companies.
I knew the Pakistani rupee was grossly overvalued at 105 to the US dollar as Sharif had squandered $7 billion in State Bank hard currency reserves to maintain an inflated exchange rate.
This unreal rupee peg to the US dollar would, I concluded, lead to a Mount Vesuvius scale volcanic eruption in the financial markets once the captains and kings in Islamabad changed, a dismal but recurrent theme in Pakistani history. So when Nawaz was sacked, I knew his game of monetary chicken on the rupee would end in tears and trigger a financial meltdown in Karachi equities. This is exactly what happened. The Pakistani rupee has plunged from 105 in 2017 to 160 (my target, published ad infinitum since August 2018) in the rupee and a ghastly 20,000 point fall in the Karachi 100 index to 32,950. We are now at the Godawful moment in Pakistani politics but destined for a “plain awful” future, a compelling argument for me to reenter the market. Why?
One, the $6 billion IMF extended fund facility is a game-changer as it unlocks World Bank, Asian Development Bank, Islamic Development Bank and even sovereign Gulf loans. The IMF bailout package was also a prerequisite for Pakistan to issue another sovereign Eurobond, a prospect publicly announced by de facto Finance Minister Hafeez Sheikh. The IMF has distributed $1 billion to Pakistan as an initial tranche, double the 2013 initial payout.
Two, Pakistan is no longer in the geopolitical cross-hairs of a Trump White House eager to exit Afghanistan with a negotiated deal with the Taliban (to avoid a Saigon 1975 scenario in Kabul 2020), apply “maximum pressure” on Iran and ally with Saudi Arabian strategic interests in the Islamic world. This necessitates a softer line with Pakistan, the reason Prime Minister Imran Khan is in Washington on a state visit. This also means World Bank/ADB funding and no real risk that Pakistan is blacklisted by the Financial Action Task Force in September. Relations with India have also improved since the two successor states to the British Raj went to war last March after the terrorist attack in Pulwama.
Three, the ineptly executed, catastrophic 40% devaluation of the Pakistan rupee has led to an inflation spike 10%, which has caused the State Bank in Karachi (run by ex-IMF “our man in Cairo” Dr. Reza Baqir) to respond with multiple draconian interest rates hikes. Yet the State Bank policy rate could well peak at 14%. After all, the IMF forecasts inflation will fall to 8% by next summer and the real effective exchange rate (REER) on the rupee is near equilibrium value. Pakistan’s hard currency reserves are now a dismal $7 billion but the IMF believes central bank reserves will rise to as high as $18 billion by next summer. A Bretton Woods macro pipe dream? Sure, yet a perfect data point in my “Godawful to just plain awful” thesis. I live in a world of second derivatives as a trader in the global financial markets and I see economic, “blood on the streets”, Nathan Rothschild’s ideal time to buy!
Four, the tax amnesty defies everything the populist Imran Khan promised the impoverished masses of Pakistan and negates the ethos of an Islamic welfare state. Yet the amnesty generated $460 million in desperately needed revenue and bought $20 billion dollars in ghost assets into the tax net. True, Nawaz Sharif’s PLMN tax amnesty bought $800 million in tax revenue in 2018 but at least Imran Khan has finally grasped that politics is the art of the possible. Hopefully, Pakistan can improve its tax collection/GDP ratio to at least Sri Lanka/Bangladesh levels.
Five, Pakistan is on the eve of a major privatization program. Dr. Sheikh, after all, was a former World Bank executive and Privatization Minister in General Musharaff’s Cabinet. This, coupled with a 'laissez-faire' Foreign Direct Investment (FDI) regime can resurrect Pakistan’s moribund industrial sector and help ameliorate its external funding gap. Imran Khan also needs to drastically cut a 3.5 million government payroll and a black hole public sector expenditure that is 23% of GDP and a shocking 7% budget deficit.
Six, the London Daily Mail’s shocking exposé of systemic money laundering by the family of ex Punjab Chief Minister Shahbaz Sharif, Nawaz’s younger brother, seriously weakens the opposition at a time when even former PPP President Asif Zardari is also in jail for corruption. Imran Khan has broken the chokehold of the dynastic kleptocracy that defined the Bhutto-Zardari and Sharif rule since the late 1980s.
Seven, the PSX 100 Index in Karachi is dirt cheap at 5.7 times forward earnings. I expect the rupee to be at 175 by year-end as the IMF mandates a free-float FX regime and the State Bank policy rate to peak at 14%. If I am right, Pakistani equities can rerate to 7 times earnings by next summer, their valuation level after the 2008 IMF loan disbursement. So the cosmic pendulum of risk-reward tells me to accumulate rupee revaluation and peak interest rate beneficiaries. This means OGDC and United Bank Ltd., I see 40% upside on both shares as I ride the macro rollercoaster in Pakistan from Godawful to just plain awful!