An undervalued PSX

Published January 1, 2024

PREDICTING the direction or magnitude of change in the movement of equity securities is a fool’s errand.

John Maynard Keynes once said that “the markets can remain irrational longer than you can remain solvent”, and the same has been proven correct time and again. We cannot predict the direction or the magnitude, but we certainly can work with whatever information is available.

The equity market in Pakistan continues to be consistently cheap across all metrics — relative to its historic levels, as well as relative to other regional and frontier markets. Market capitalisation, which represents the sum of market value of all companies listed on the stock exchange relative to the GDP, continues to remain lower than its long-term average.

Pakistan’s market capitalisation to GDP ratio has averaged around 23 per cent during the last twenty years but remains around 17pc.

As long as the government continues on its debt-induced consumption-oriented binge, the equity markets will remain directionless and choppy

Similarly, inflation over the last five years has compounded by more than 100pc, but equity prices have yet to catch up to inflation, even though earnings continue to increase. The price-to-earnings ratio is another key metric that one can use to assess whether a stock or market is undervalued or overvalued.

Over the long run, the average price-to-earnings ratio for the KSE-100 index has been around nine times, which is still fairly low for an emerging or frontier market. During the last five years, the ratio has fluctuated between four and five times and has reverted to less than five times following the recent downward price correction.

Every single valuation metric indicates an equity market that is undervalued and has stayed that way for the last many years.

Maybe a structurally undervalued market points towards a deeper and structural problem that traditional market valuation metrics can’t capture.

Economic growth has been in the doldrums in the last few years, and any significant growth spurt attained in the last decade can largely be attributed to a consumption-oriented, import-fueled growth model — funded by external debt. Growth remained a function of external debt-driven consumption-oriented growth, while investment and exports as a percentage of GDP saw their share decline consistently.

From fears of sovereign default to the painful start of the course correction process, the last year made progress of sorts. Arguably, the most economically significant event of 2023 was the creation of the SIFC with its many promises of foreign investment. Elections and the nascent hope for political stability will define the year ahead. However, the house of cards may fall without the IMF.

Consistently irresponsible fiscal policies of successive governments have led to a scenario where large sectors of the economy remained cash-strapped. The government to fund its spending spree continued to crowd out private sector credit, squeezing the availability of credit for private sector growth. Government-backed assets make up more than 70pc of banking assets, effectively making them conduits for sovereign debt. Oil, gas, power, and other allied segments remained cash strapped as liquidity remained stuck in circular debt.

As critical segments of the economy remain beholden to a spendthrift sovereign, the valuations of these entities started reflecting the same. Effectively, the price of any asset is the present value of its cash flows — the value of an asset that has its cash stuck with the sovereign without any recourse will perpetually remain depressed till the time structural issues are resolved.

It is estimated that eight out of the ten biggest companies making up the KSE-100 index are directly or indirectly related to the sovereign, whether through being its lenders, depending heavily on some concession provided by the sovereign, or by having its liquidity stuck with the sovereign.

The market may be depressed, but it is depressed because of a dysfunctional sovereign that refuses to bring about structural changes and continues to fund its deficits through more borrowing, whether local or foreign. This is sovereign risk at play here, which will continue to overshadow the private sector and asset prices until reforms are implemented.

Net government borrowings make up 82pc of broad money, which is its highest ever level — effectively meaning that the government continues to borrow to bridge its deficits without making any structural amends. Such heavy reliance on borrowing will continue to keep interest rates elevated while continuing to drive out private-sector credit, further squeezing the ability of the private sector to innovate or simply operate at this point.

The direction that the equity prices take in 2024 will largely be determined by the ability of the sovereign to undertake serious reforms and instil confidence in the market. Considering 2024 is an election year, it will be even more crucial for the new government to demonstrate that it can actually undertake serious fiscal and structural reforms rather than rinse and repeat its tried and tested playbook that has only yielded failure.

Interest rates will remain elevated until the government reduces its demand for borrowings by instilling fiscal discipline. As long as the government continues on its debtinduced consumptionoriented binge, moving from one emergency foreign currency injection to another, the equity markets will remain directionless and choppy.

The market remains undervalued, but that is largely a function of the sovereign that refuses to mend its ways and push the economy on a sustainable growth trajectory.

The writer is an independent macroeconomist and energy analyst


DR HAFIZ A. PASHA
Former caretaker finance minister

THE forthcoming year, 2024, is likely to be characterised by a very high level of uncertainty on both the political and economic fronts, with one impacting the other. Will the elections, if held, yield a clear majority for one political party, which will then equip it to exercise strong governance? The current financial year will proceed up to March 2024 under the umbrella of the International Monetary Fund (IMF) Stand-by Facility.

However, despite the presence of this facility, the inflow of external non-debt and debt-creating inflows has visibly diminished.

Consequently, the foreign exchange reserves have already fallen below $7 billion. The coming months include some lumpy payments and higher debt servicing. Therefore, by the end of the Stand-by Facility, reserves could once again be at a relatively low level. This risk has already been highlighted by the IMF.

Pakistan may have no option but to go for an Extended Fund Facility with the IMF, with difficult negotiations by the new government on the agenda of economic and financial policies. The annual external financing requirement will be up to $25bn, depending upon the extent of rollover of debt.

The time may probably come later in 2024 when, in the presence of some facilitation by the IMF, Pakistan opts to seek some reprofiling or even restructuring of external debt owed to bilaterals and private lenders. This will have to be combined with an extraordinarily tough reform agenda to build credibility with lenders.

The process of implementation of deep and wide-ranging reforms will inevitably imply the continuation of the high rate of inflation and low rate of economic growth. Poverty and unemployment levels will remain high.

The ultimate market test will be faced by the incumbent government of operating in a very difficult environment. We hope and pray that elections are held in time, and they yield a representative government which is willing to take tough decisions to bring stability and the process of growth back to the country.


RASHID AMJAD
Former vice chancellor PIDE

AS in the recent past, the economy will continue to muddle through 2024. The real economic question is whether the new power structure after the elections in February 2024 will continue with the current International Monetary Fund (IMF) standby agreement.

With a severe foreign exchange financing gap of over $20 billion per year, the choices are limited. If extended, a new IMF programme will stabilise the economy but throttle growth. If not, unless large doses of foreign direct investment materialise, the country will live under the shadow of impending default.

Re-igniting growth will remain the government’s biggest challenge, together with reigning in unprecedented high inflation.

An import-intensive export growth strategy is a nonstarter without the foreign exchange to support it. So, this leaves only the domestic market, where prudent price incentives and support measures could stimulate growth.

But continuing high interest rates — essential to slow down inflation—will frustrate new investment.

The only real option is to continue under the IMF/ World Bank shadow and hope for a good wheat harvest and robust agricultural growth to stimulate manufacturing and services.

The huge undocumented informal sector has its own growth dynamics, which will keep the economy afloat. The tenacity for reforms to move towards growth with macro stability will be severely tested.


ZAFAR MASUD
CEO and President, the Bank of Punjab

AS we enter 2024, we should be prepared for new challenges and new opportunities. The world is going through a political and economic transformation, with almost half the global population voting this year in at least 64 countries (plus the EU) — including Pakistan, the USA, and India.

Hence, 2024 will be a defining year for establishing a new global political agenda that will have far-reaching implications on critical economic, social, and climate sustainability actions.

I remain cautiously optimistic about Pakistan’s economic outlook, with the newly elected government taking office in 2024 and working towards improved regional and global relations. We will have to find a delicate balance between our traditional foreign policy objectives and the fast-evolving political landscape in the wake of ongoing conflicts across the globe.

A fresh social contract in the new political set-up is an absolute must, which would be the basis of required reforms in the country. A broad political consensus — as the Charter of Society — would be best suited to address the critical reforms.

All our economic challenges, including the balance of payment crisis and paucity of foreign currency, rests with our fiscal policy. The good news is that these challenges are fixable, and it’s all in our own hands. We must work towards addressing them without fail and any further delays, starting from tackling the existing lopsided subsidy structure that needs to be repositioned from a trickle-down to the bottom-up approach.

There should only be targeted subsidies for the poor and vulnerable (using the national socio-economic registry/Benazir income support programme scorecard) and for promoting exports and investments (through time-bound and performance-driven mechanisms).

The overall governance structure should be more inclusive and squarely merit-oriented, which is necessary for implementing the trilogy plan — privatisation, sovereign wealth fund, and implementation of the state-owned enterprises law.

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