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Strategy| Pakistan
22 Apr 2015 Pakistan Strategy
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Pakistan Strategy April 2015
Chart 1: CPEC to cut distance to Shanghai from Middle East/Africa by over 70%
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Pakistan Strategy April 2015
Macro implications
Table 1: Pakistan remains net importer of The CPEC earmarks wide-ranging opportunities for improving economic prospects as it
goods from China addresses two key stumbling blocks to growth at present: (1) energy deficit, and (2)
US$bn FY12 FY13 FY14 financial/fiscal constraints. We see potential economic growth prospects in the medium term
Exports to China 2.09 2.70 2.69 as: (1) investment to GDP ratio looks set to increase close to 20% in next 3 years, (2)
as % of total 8% 11% 11% reduced energy supply-demand gap to boost large scale industries (particularly textile), (3)
Imports from China 4.63 4.73 5.98 local industries will likely receive a boost given financing opportunities coming from Chinese
as % of total 11% 12% 14% companies, and (4) improved rail/road network benefits transport and trade sectors.
Balance of Trade (2.54) (2.03) (3.29)
Source: SBP Financing commitments to improve PSDP outlook
Majority of the energy projects are apparently planned to be financed through private
companies, while major infrastructure projects eyed by the PML-N government under Public
Sector Development Program (PSDP) will also see daylight including, Khi-Lhr motorway,
Metro train project, upgrading Karakorum highway and Gwadar port area, which is expected
to be part of next years PSDP budget. Assuming ~90% of the total US$8bn allocation will
Chart 2: Investment/GDP ratio has not likely be financed under PSDP (as per budgeted allocation for CPEC in FY15), required
received any significant boost since FY06 PSDP of ~PRs700bn (incremental ~2% of GDP) though expected to be majorly financed by
20.0% 5.0% foreign aid over a period of 3 years will likely pose a challenge for the govt during the first
year of implementation (FY16) given strict fiscal deficit target (4% of GDP) under the IMF
4.0%
15.0% program (concluding by mid-2016). Recall that growth in PSDP has remained sluggish
3.0% (PSDP/GDP ratio has remained between 2.5%-3.5% in part 5 years) due to low revenue
10.0%
2.0% mobilization and financing constraints.
5.0%
1.0% Increased trade: Export diversification will be key
0.0% 0.0% The project envisages increase in annual trade volume to US$20bn from US$15-16bn
reported at present (including services). However, Pakistans imports from China constitute
FY15E
FY16E
FY09
FY10
FY11
FY12
FY13
FY14
60-70% of trade volume at present. Hence, burden of an unfavorable balance of trade could
Investment/GDP (LHS) PSDP/GDP potentially increase and hurt local industries due to increased competition. Major imports
GDP growth
Source: Pakistan Economic Survey include electronic items and capital goods; we suspect increased import of machinery for
planned new and up-gradation infrastructure projects to contribute to import bill ahead. Major
exports to China remain cotton yarn, fabric, and leather; where, looking ahead, export
diversification will be crucial to reap major benefits.
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Pakistan Strategy April 2015
Power
The power sector is likely to be the biggest beneficiary of the CPEC, in our view. Broadly, the
planned projects will serve to alleviate chronic power shortages by helping Pakistan achieve
two long-term solutions: (1) rationalize power fuel mix, and (2) increase generation on
indigenous fuel sources. The sheer magnitude of new projects (about 16,000MW, which is
about 70% of the current installed capacity) to be added to the countrys power supply not
only is sufficient for addressing the existing demand-supply gap but will also support the
elevated economic growth it is likely to spur. CPEC will also direct investment in the weakest
segments of the power chain specifically, new transmission lines to support the surge in
Chart 3: Favorable shift in power mix generation. These attributes will in turn automatically resolve the circular debt issue that has
40% 37% been plaguing the sector, in our view. All in all, the power projects under the CPEC promises
35% 29%
30% to turnaround the power sector of Pakistan.
30% 27%
25% 23% 23% Rationalizing power fuel mix will resolve power outages
20% 16% The CPEC has set out to add 1,590MW of hydropower, about 6,000MW of coal-fired plants,
15% in addition to about 1,000MW of solar plants, and nuclear and wind power plants (refer Table
10% 8%
3). All these projects bear a common theme: cheaper electricity using indigenous/renewable
5% 3% 3%
0.1% 0.4% sources. With these projects online, the country will no longer be largely vulnerable to fuel
0% price shocks (for example, oil prices which culminated in an often insurmountable cash-flow
RFO Gas Hydel Coal Nuclear Wind &
Solar crisis), in our view. The solar and wind power projects, though much smaller compared to the
2014 2021E overall installed capacity of Pakistan, is a step towards diversifying power sources and
Source: KASB Research aligning Pakistan with the global trend towards renewable sources.
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Pakistan Strategy April 2015
Table 5: Demand-Supply dynamics of Pak Both North and South players to reap benefits
cement sector The agreed infrastructure projects include development of Gwadar port, where Pak-China
(mn tons) FY15E FY16E FY17E FY18E have initiated a feasibility study on Gwadar Hospital, while an MoU has been signed with
Total Demand* 36.4 38.1 39.7 41.6 reference to a provisional governmental concessionary loan for building Gwadar International
Total Demand** 36.4 39.4 41.0 42.9 Airport (US$266mn) as well. With reference to Gwadars location, we believe South cement
Capacity 44.6 44.6 44.6 44.6 players will be key beneficiaries of the aforementioned projects. Moreover, major
Utilization (%)* 82% 85% 89% 91% development/upgrading of highways was also the focus of the agenda between the two
Utilization (%)** 82% 88% 91% 93%
countries, with as many as 4 MoUs signed in this regard. Projects include up-gradation of
Source : KASB Estimates / * Base Case /** Post Pak-China Karakorum Highway (Havelian to Thakot), development of Karachi-Lahore Motorway
Infrastructural Projects (Scenario 1)
(US$360mn) and Gwadar port East Bay Expressway project. Projects in this category will be
beneficial to players in both the North and South region. Commitment on financial
arrangements for several hydropower projects, such as 870MW Suki Kinari Hydropower
Project (US$1.08bn) and 720MW Karot Hydropower Project (Rawalpindi, Punjab), were also
chalked.
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Pakistan Strategy April 2015
Banks
Credit demand and non-fund income potential enhanced
We see medium-term positives in primarily two areas for Pakistan banks: (1) credit demand,
and (2) non-fund income potential. First, Pakistan banks are likely to be heavily involved in
financing the equity portion of power projects developed under these agreements. Second,
industrial demand generated in sectors such as cements, metals, chemicals,
telecommunications and services through ambitious physical infrastructure projects should
also subsequently drive working capital and project financing demand. Finally, in the long
term, assuming reduced energy demand-supply gap, better law and order situation and
improved infrastructure deployed nation-wide, the economy should experience sustained
private credit demand, hitherto severely restricted amid energy and law and order problems.
Rising trade volume targets between China and Pakistan may drive higher trade
commissions. Here, finalization of FTA in banking sector between the two countries enabling
branch operations of banks of one country in another, will also bode well for trade
commission and remittance fee income heads. HBL and NBP will reportedly be the first banks
to open branches in China, whereas ICBC is already active in Pakistan. Few Pakistan banks
including UBL, NBP and HBL currently operate representative offices in China.
Agreements relating to (1) financing cooperation in implementing CPEC between ICBC and
HBL, and (2) promotion of Chinese investments and industrial parks developments in
Pakistan between ICBC and HBL may bode positive for the sector.
We recommend playing this theme in Pakistan Banks via: (1) HBL (PO: PRs213, Buy) as it
has already signed agreements with Chinese counterparties, has sufficient international
banking experience, and maintains active presence in the region already, (2) MCB (PO:
PRs305, Neutral) as the bank has highest capital space available to pursue aggressive
lending, (3) ABL (PO:PRs125, Buy) given its lowest level of ADR and one of the highest
capital room to expand credit risk, and (4) UBL (PO: PRs215, Buy) given the banks existing
presence in China and its valuable experience in international banking.
Political ownership of the project from opposition parties and military support remain
crucial: A broader buy-in from major political parties is already in place. The CPEC is
envisaged to pass through all four provinces and the focus of investment in infrastructure and
energy projects will benefit all four provinces.
Security concerns: The law & order situation in Gwadar and Gilgit Baltistan, the entry and
exit points of the corridor, is volatile and requires added measures. On its part, Pakistans
army has announced establishment of a separate division of armed forces to provide security
to projects under CPEC.
Geo-political tension: Geopolitical tensions with Iran given an active Gwardar port will be in
direct competition with Iranian port, Chabahar, when it comes Chinas access to Central Asia
and Africa and Europe.
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Pakistan Strategy April 2015
Upgradation of Karakorum Provision of Chinese governmental concessional loan for the second phase of upgradation of Karakorum Highway (Havelian
Highway to Thakot) between MoC of China and MoFEA of Pakistan;
Karachi-Lahore motorway Provision of concessional loan between MoC of China and MoFEA of Pakistan for Karachi-Lahore motorway
Gwadar International Airport Provision of Chinese governmental concessional loan between MoC of China and MoFEA of Pakistan
major communications
framework agreement on co-operation on major communications infrastructure project between China and Pakistan;
infrastructure project
Upgradation of ML1 +
A joint feasibility study of the framework agreement between the NRA, China and the MoR, Pakistan
establishment of Havelain Dry port
Telecom
Sister cities relationship protocol on establishment of Sister Cities Relationship between Chengdu city Sichuan Province of PRC and Lahore City;
protocol on establishment of Sister Cities Relationship between Zhuhai City, Guangdong province of China and Gwadar city,
Sister cities relationship
Balochistan of Pakistan;
protocol on establishment of Sister Cities Relationship between Karamay City, Xianjian Ugur, autonomous region of China and
Sister cities relationship
Gwadar city
Source: Business Recorder, KASB Research
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Pakistan Strategy April 2015
Analyst Certification
I, Fawad Khan, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and
issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed
in this research report.
Sarah Mazher Pakistan Macro & Autos +92 21 111 222 000 Sarah.kamran@kasb.com
Muhammad Saad Ali Power, OMCs, & Chemicals +92 21 111 222 000 ext 448 Saad.ali@kasb.com
Farid Aliani Banks & Insurance +92 21 111 222 000 ext 332 Farid.aliani@kasb.com
Ameet Daulat Fertilizers & Consumer +92 21 111 222 000 ext 337 Ameet.daulat@kasb.com
Mohammad Ali Amin Cements +92 21 111 222 000 ext 331 Mohammad.ali1@kasb.com
Ahmed Hanif Technical +92 21 111 222 000 ext 383 Ahmed.hanif@kasb.com
Abdul Wadood Manager Database +92 21 111 222 000 ext 334 Abdul.wadood@kasb.com
M. Noman Mughal Library +92 21 111 222 000 ext 339 Noman.mughal@kasb.com
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Pakistan Strategy April 2015
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