JP Morgan sees investment opportunities in Pakistan’s sovereign credit

KARACHI: American multinational investment bank JP Morgan sees more opportunities in Pakistan’s sovereign credit with caution about challenges related to implementation of IMF’s recalibrated program, as the country is expected to tap international debt market for additional $1.5 billion.

In a latest report, JP Morgan said there have been positive developments in Pakistan in recent months related to resumption of International Monetary Fund’s (IMF) deal, improving current and fiscal account deficits and growth recovery.

“The favourable read-through from recent IMF developments has been credit positive amid strong investor interest towards Pakistan. We add a new outright Pakistan 8.25 percent 2024 long,” it said.

However, there are challenges related to “risks around current account deterioration from fading remittances and higher commodity prices, elevated risks of frequent COVID-19 waves given low levels of vaccination weighing on the growth outlook, largely negative real yields, and political pressure to stimulate growth, which would presumably require a reappraisal of IMF program targets,” it added.

After a three-year absence from the Eurobond market, Pakistan issued $2.5 billion in a triple-tranche Eurobond in April following the resumption of the IMF program that boost investor interest.

The country is expected to raised additional $1.5 billion of gross sovereign issuance to year-end, which might come around the time of the $1 billion Eurobond maturity in October.

JP Morgan expects implementation of the current $6 billion extended fund facility of IMF to remain challenging. After being suspended for almost a year due to COVID-19, EFF resumed in March 2021. The original program started in July 2019, but after completing a first review in December 2019, both parties agreed to suspend it as the COVID-19 shock completely changed the macro-picture.

Despite IMF being sympathetic to government’s desire to make changes to the IMF’s recalibrated agreement, “further deterioration of Pakistan’s COVID-19 situation against a backdrop of low vaccination levels is a headwind weighing on the growth outlook and the ability to achieve the recalibrated IMF program targets”.

In FY21, fiscal deficit is expected at 7.1 percent of GDP. Debt-to-GDP continued to decrease again in FY22 (81.5 percent) compared to 83.9 percent in FY21, down from a revised 87.6 percent in FY20. The current account deficit is expected to deteriorate in FY22. The current account deficit is expected at $8 billion (2.4 percent of GDP) in FY22, from $2.3bn in FY21.

Foreign exchange reserves (excluding gold) are expected to rise to around $19.1 billion by June 2022, from $16.8 billion in April 2021. This is due to relatively strong financial flows from Eurobond issuances, as well as bilateral and multilateral flows. “Crucially, the Central Bank’s more flexible stance on the exchange rate makes it easier to make FX purchases and reduce its net short swap/forward FX position.” The real policy rate in Pakistan is deeply negative (-3.9 percent when deflated by headline inflation, and just mildly positive when deflated by core inflation).

“We have been flagging how a rate hike might be necessary as global financial conditions become less supportive,” it said. “We expect a 100bps policy rate hike later this year, but risks of no-action remain high.”

Pakistan was a large and stable sovereign underweight in JP Morgan emerging market client survey since the start of 2019.

“However, investors sharply covered their shorts, moving the credit back to neutral in April. This both corroborates anecdotal conversations with investors waiting for the new issue to re-engage in Pakistan following the positive IMF program momentum, and explains the strong price action for the new Eurobonds issued in April, which increased 4-7pts just days after issuance,” it said. “The similarly strong demand for the recent $500 million debut quasi sovereign green Eurobond, with a final order book of around $3 billion might result in spillover and further near-term demand for the sovereign bonds.”