Eurobond Issue: Strengthening road to recovery
In the recent time, the signs of economic recovery have gained strength as the country’s balance of payment situation improves. Materialization of foreign flows, particularly in Pakistan Development Fund (PDF), and release of third tranche worth US$522mn by International Monetary Fund (IMF) has pushed the country’s forex reserves in double digits after a lapse of 6-mths. From a recent low of US$7.6bn (as of Feb 07’14), the country’s forex reserves has shored-up by approx. 32% to US$10.0bn by end of Mar’14. Bifurcating the numbers, reserves held by central bank had reached US$5.4bn, where holding of commercial banks stood at US$4.7bn. This implies strengthening of import cover to around 2.9-mths from 2.2-mths in Feb’14.
The story of improving external account has continued in the recent Eurobond road shows. Repost of foreign investors’ confidences in Pakistan revival story has culminated into US$2bn bond placement versus initial target of US$500mn. Materialization of flows can potentially accelerate the government’s economic recovery drive by positively impacting other macro-economic variables, we believe.
Impact #1: Improved import cover, stable PkR‐US$ parity
The crystallization of said flows has drastically altered the country’s external account outlook. Our calculations suggest that higher than envisioned eurobond flows are likely to take country’s forex reserves to US$11.5‐12bn by the FY14. Our assumptions include i) normalized current account deficit, ii) US$500mn foreign component of 3G/4G auction (to be held Apr 23’14) and iii) matching of IMF loan repayments with its 4th tranche (due in Jun’14). Early disbursement of CSF and realization of privatization proceeds will add a potential upside to our base case forecast.
In this backdrop, the import cover is anticipated to strengthen to a respectable level of 3.5‐mths and hence, imparting stability to PkR‐US$ parity. The improving forex flows has already shed its effect on the parity with PkR standing amongst the best performing currencies of the past month.
Impact #2: Softening of inflation outlook
The improved PkR‐US$ parity has also softened the future inflation expectation. The inflationary pressures have already depicted signs of easing (Mar’14 CPI at 8.53%) and we expect average FY14 inflation to stand around 8.5% (slightly below the IMF projection of 8.8%). Subject to the budgetary measures, FY15 average inflation can clock in the range of 7.5‐8.0%.
Impact #3: A potential room for monetary easing
Given higher forex cover and inflationary pressures at comfortable levels, we believe there would be an increased room for the monetary policy authorities to swing their verdict towards growth. In this regard, government’s effort to bring its fiscal house in order (evident from reduced reliance on budgetary borrowing) will also play in favor of authorities’ decision to tilt towards growth in the next 6‐mths.
Impact #4: placing Pakistan’s privatization process in the investors’ radar
Lastly, the substantial flows in the eurobond issues is likely to firm‐up the spotlight on Pakistan once again. This bodes well for the upcoming privatization exercise with government playing to disinvest its stake in OGDC (10% stake), PPL (5% stake) and UBL (20%). A higher eurobond subscription can potentially make a convincing case for increased global investors participation in these equity issues and can allow the government to place a better negotiating price.