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The Global X MSCI Pakistan ETF (PAK) offers a trailing dividend yield of 9.42% and an estimated forward dividend yield of 8.0%. We believe that threats to dividends have declined over the past few months as it now appears that the monetary tightening cycle in Pakistan has ended and currency risk has substantially subsided. However, we believe that economic growth problems will persist for the next couple of years, thereby restraining corporate earnings growth.
External Position and Inflation No Longer Require Further Monetary Tightening
We believe that State Bank of Pakistan is no longer pressured to raise interest rates to support the Pakistan Rupee, PKR. Our conviction is based on the stability in the exchange rate over the previous months as well as our outlook for the country’s balance of payment.
We expect imports to continue to decline in the coming year due to economic slowdown and devalued PKR, which will help support Pakistan’s current account balance. The country’s external position is also likely to receive support from workers’ remittances.
The 50bps cut in Fed Funds rate so far this year will also lower pressure on PKR and potentially increase financial flows, as noted in the latest monetary policy announcement. However, further benefit from interest rate differential is not expected as we do not anticipate another rate cut by the US Federal Reserve this year. The dissent by three members in the September FOMC meeting, two against a rate cut and one for a further cut, does not give a clear signal about the future direction of interest rates in the US. Nevertheless, we expect the Fed to hold rates at current level as we believe the trade war will not worsen much from the current level.
Unlike imports, remittances, and the US monetary policy, Pakistan’s exports are unlikely to offer much support to the country’s external position. We expect Pakistan’s exports growth to continue to remain lackluster for the next couple of years because of internal factors, like energy supply constraints, and the US-China trade war. Economies of Pakistan’s largest trade partners, which include US, EU and China, are all exposed to the trade war, which will negatively affect Pakistan’s exports to these countries. The Organisation for Economic Cooperation and Development, OECD, has also recently slashed down its 2020 global economic growth outlook to 3.0% from previous forecast of 3.4%.
Inflationary threats are also now considerably lower than when we wrote our last report on Pakistan’s economy. The recent spike in international crude oil prices are unlikely to have a significant impact on inflation as it appears that oil supply will soon return to normal. We continue to expect WTI crude oil price to fall to $55/bbl by the mid of 2020. Moreover, stability in the exchange rate will keep further imported inflation as bay.
Due to our forecast of stable exchange rate and inflation, and outlook of economic slowdown, we expect the State Bank of Pakistan to maintain its target policy rate at the current level (13.25%) for the next six months. This bodes well for our outlook on corporate earnings as it will lead to no further increase in cost of debt. Moreover, it will reduce the flight of capital from Pakistan’s equities to fixed income market, thereby providing support to PAK’s constituents.
Corporate Earnings Likely to Remain Lackluster but Worst is Behind Us
Due to our economic outlook, it appears as if the worst for corporate earnings is behind us. However, we also do not expect much upside due to austerity measures that Pakistan’s government has already taken, which include hike in electricity and gas prices and taking back of promised future corporate tax rate reduction. At the time of announcement of the IMF program in July 2019, IMF called the austerity measures Pakistan’s government had taken in the FY20 budget “an important initial step”, which leads us to believe that further austerity measures may be on the cards. Pakistan’s government appears committed to the fiscal discipline required under the new IMF program, as recently noted by IMF’s Middle East and Central Asia Director. These possible future measures pose a threat to our thesis, as they can lead to greater decline in earnings and dividends than we currently foresee. For now, we have not taken them into account as they have not been announced.
PAK Offering High Dividend Yield of 8.0%
PAK has paid dividends of $0.59 in the last twelve months, which gives a trailing dividend yield of 9.42% (using market price of $6.26 at the time of writing of this report). Due to austerity measures, we expect earnings, and consequently dividends, to face some downward pressure. Consequently, we expect dividend to drop by 15% to $0.50, implying a yield of 8.0%.
Conclusion: Upgrading Stance to Neutral
Due to our economic outlook, we are expecting no price appreciation for PAK in the next twelve months. We do, however, expect the ETF to pay dividend of $0.5/share in the next one year, which takes the dividend yield to 8.0%. The yield in turn takes the total expected return in the next one year to 8.0%. Consequently, we are upgrading our stance on PAK from Bearish to Neutral.
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.
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