PAK: The Roaring Tiger Has Returned

| About: Global X (PAK)
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The performance of the Pakistani stock exchange has been upbeat.

I expect status quo in upcoming MPS.

Brexit had a negative effect on the PAK ETF.

In this article, I would apprise the readers about the effects of various events and their impact on the Global X MSCI Pakistan ETF (NYSEARCA:PAK). However, before indulging into the relevant events affecting the fund, I would like to present the performance of Pakistan's equity market relative to its regional and global peers.

The following graph depicts the performance of the KSE-100 index relative to its regional peers. Pakistan's benchmark index has outpaced all its rivals as it climbed by ~19.3% during this calendar year. Additionally, the country's equity market performance has also been commended in the international financial newspapers, which termed it as one of the best performers in Asia and the world.

Further, the following graph shows the performance of the KSE-100 index relative to other international indexes.

Recent Monetary Policy

One of the main events was the announcement of a monetary policy that was given by SBP (State Bank of Pakistan) on 30th July, 2016. As expected, the Monetary Policy Committee (MPC) adopted status quo by keeping the target and discount rate unchanged at 5.75% and 6.25% respectively. Despite an expected real interest rate of +200 bps in the near term, the SBP maintained its conservative stance and kept the interest rates unchanged.

Moreover, according to my estimates, in 1HFY17 there would be attrition in the real interest rate, and it would be hovering around 160-170 bps compared to the average +300 bps in FY16. Additionally, in order to elaborate my previous point, the compression in real interest rate would occur mainly due to a gradual recovery in commodity prices coupled with depreciation of PKR/USD, resulting in upward pressure on CPI in FY17.

On the flip side, it is to be noted that in the recent auction of T-bills and PIBs, their cut-off yields shrank by ~18-20 bps and 20-22 bps respectively. This indicated that the banking sector was expected a rate cut. However, the recent MPS did trigger an upward rally in the banking sector (~27% of the ETF).

Brexit Snapshot

In an unprecedented move, the people of the U.K. opted to leave the EU in a neck-and-neck referendum. However, the U.K.'s decision had an overwhelmingly negative impact on global financial markets, as almost ~$2 trillion evaporated within a matter of days. Pakistan's equity market was no exception - the result of a referendum trimmed most of the gains the bourse made after the MSCI's decision to include Pakistan into an emerging market index. That day, the KSE-100 index plunged by ~2.2%.

As for the potential impacts of Brexit on the PAK ETF, the oil & gas sector (constitutes ~20% of ETF) has been unfavorably affected by Brexit, as this has led to a plunge in oil prices, which results in a compressed gross margin for the companies operating in this sector. Automobiles (constitute ~3.2% of ETF) have been negatively affected, as most of the parts and accessories are imported from Japan. Additionally, it is to be noted that JPY has gained almost ~16% CYTD against the USD, thus increasing the cost of production and resulting in gross margin attrition. Further, according to my analysis, every 1% increase in JPY would prune the automobile's earnings by 1.2-2% per annum. Textiles (constitute ~1.8% of ETF) have been inversely affected, as a major chunk of Pakistani exports go to member countries of the European Union. Therefore, due to Brexit, Europe-bound deliveries would remain depressed and are expected to be volatile. NML (Nishat Mills Limited) is the only textile stock in PAK ETF, contributing ~1.8% to the net assets of the ETF. It is worth noting that 25-27% of the company's revenue is composed of exports. Moreover, a steep depreciation of the euro against PKR would further erode the earnings of the export-oriented sector by ~2-7%. Additionally, a weakening pound or euro would mean Pakistani goods would be expensive in European markets.

Furthermore, as far as the macro side of the Pakistani economy is concerned, the country may benefit from a dip in oil prices following a strong greenback due to Brexit. I expect the Pakistani rupee to remain stable at an average PKR/USD parity of 106 in CY16 in the backdrop of strong forex reserves coupled with weakening commodity prices. Plus, it should be noted that the country's foreign exchange reserves are at an all-time high of $22 billion. Moreover, a strengthening PKR would make external debt servicing and repayment easier.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.