2. Page 2
Pakistan Strategy – June 2016
Budget FY17: Reforms set to persist;
recovery in agri to lift growth
Budget 2016-17 envisages total outlay of PRs4.89tn (+9% YoY). The last budget under the
ongoing IMF program retains the dual focus of maintaining momentum on fiscal reforms
(fiscal deficit target of 3.8% vs 4.3%) while leveraging the gains on macro stability to lift
economic growth (5.7% target vs 4.7% in FY16) towards medium-term target.
We believe the latest federal budget presented to the Parliament reflects the government’s
intent to address the weak links in the current macro backdrop. However, implementation of
growth-centric reforms and fiscal consolidation both need firm attention throughout the year.
We highlight fiscal consolidation targets might be viewed skeptically as the IMF program ends
in Aug-16. Five key themes of the budget are as follows: (1) propel growth momentum amid
price stability via recovery in agriculture sector and increase in PSDP, (2) fortify external
stability by giving boost to export sector, (3) fiscal consolidation, (4) increased efforts for
documentation of the economy, and (5) encouraging backdrop of corporate earnings.
#1: Favorable measures to propel growth momentum
We believe the reforms should facilitate the rising GDP growth momentum, and expect
growth to exceed 5% in FY17E, however, largely depict more of the same.
Pro-agri measures: Following the big Kissan package announced last year by the Prime
Minister, we believe the government’s resolve to boost farmer income via several pro-
agriculture sector measures announced in federal budget (refer Table 4 for measures in
detail) is a positive step towards improved prospects for both (1) crop yields, and (2) industrial
demand dynamics. Not only should it help agriculture sector to churn out positive growth in
FY17 vs -0.2% in FY16, but LSM sector performance should also receive a boost on the back
of higher rural demand for consumer durables, autos, cement, steel, construction etc.
Development spending: Another important driver is the increase in public sector
development program (PSDP) by 20% to PRs1.675tn. Major heads are transport with
allocation of PRs229bn, which include 8 projects under China Pakistan Economic Corridor
(CPEC), and power sector (PRs130bn).
We are more cautious and less optimistic of the govt.’s stated GDP growth target of 5.7% for
FY17. Factors that curb our enthusiasm for high demand, high growth story are as follows: (1)
budget documents reveal the government’s intention to heavily rely on borrowing from banks
in FY17 (35% of deficit financing), which could curtail the nascent growth in credit supply to
private sector, (2) our view on significant gains in electricity supply goes beyond FY17 once
Chart 1: Major source of deficit financing is
expected to be banks in FY17
-0.5
0.0
0.5
1.0
1.5
2.0
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16B
Bank borrowing* Non-bank
External
Source: MoF
Table 2: Pakistan Macro Targets
FY16P FY17T FY17E-KASB
GDP growth 4.7% 5.7% 5.0-5.25%
Agriculture growth -0.2% 3.5% -
Industrial growth 6.8% 7.7% -
Services growth 5.7% 5.7% -
CPI inflation (YoY) 2.8% 6.0% 4.70%
Source: MoF, KASB estimates
Table 3: Medium-Term Economic Estimates
FY16
(Budgeted)
FY16
(Revised)
FY17 (Budget) FY18E FY19E
Real GDP Growth 5.5% 4.7% 5.7% 6.2% 7.0%
Inflation 6.0% 3.5% 6.0% 6.0% 6.0%
Total Revenue 15.1% 15.9% 16.0% 15.9% 16.1%
Tax Revenue 12.0% 12.6% 12.9% 13.4% 13.9%
Total Expenditure 19.4% 20.2% 19.8% 19.4% 19.6%
Current 14.9% 15.9% 14.9% 14.6% 14.6%
Development 4.5% 4.3% 4.7% 4.8% 5.0%
Fiscal Balance -4.3% -4.3% -3.8% -3.5% -3.5%
Total Public Debt 62.0% 64.8% 61.4% 57.8% 54.3%
GDP at market prices
30,672 29,598
33,509 37,944 43,215
Source: Budget Brief
3. Page 3
Pakistan Strategy – June 2016
CPEC projects come online, which puts a cap on the productive capacity, hindering growth.
The government reportedly expects to add 5,304MW of electricity in FY17, and cumulative
10,000MW by Mar-18. We also highlight risk of potential inflationary pressures due to the
potentially high demand, low supply scenario in the near-term, with additional demand boost
due to increase in minimum wage, and pensions announced by the government.
Impact on inflation: We expect limited inflationary impact from the budgetary proposals.
Prices of cigarettes are likely to increase by an average of 10-15%, with a CPI impact of
25bp. However, due to price increase announced in two phases (June and December), the
impact on full year average CPI estimate would be watered down. Additionally, removal of
concession on powder milk, whey powder/yoghurt, beverages and possibly milk as well as
marble, steel, and FED increase in cement would impact food and construction/house rent
indices; though we believe the impact should not be material.
Table 4: Addressing key areas of growth
Pro-Agricultural sector Further reduction in price of urea to PRs1400/bag from Jul-16 via subsidy and reduction in GST to 5% from 17%
Further reduction in price of DAP to PRs2500/bag from Jul-16 via higher subsidy
Agriculture credit is being increased by another PRs100bn to PRs700bn
Reduction in mark up rates of ZTBL, NBP, Bank of Punjab and Punjab Cooperative by 2%.
Sharing risk of non-payment of credit by small farmers by guaranteeing up to 50% of the financing
Off-peak rate of PRs8.85/unit for agriculture tube wells is being reduced to PRs5.35/unit
Duty on import of machinery for the dairy, livestock and poultry sectors reduced to 2% from 5%
Concession of customs duty for fish farming
Tax relief on cool chain machinery used for food processing
Exemption of sales tax on pesticides
GST exemption to Silos for grain storage
Pro-Exporter measures
Zero rating restored on 5 exports-oriented sectors; 3% tax on inputs removed, 5% on locally finished goods
maintained.
The above sectors include textile, leather, sports goods, surgical goods and carpets.
50bp cut in exporters financing rate (to 3%) eff. July 1st
PRs6bn allocation to bring Trade policy into operation
Drawback of Local Taxes scheme to continue
Technology Upgradation Fund for (1) SMEs to encourage investment in non-traditional exports and (2) textile sector
Duty free import of textile machinery, concessionary duty on man-made fiber not produced locally, to continue
All the pending GST refunds approved till 30th April will be paid by 31st August 2016
Other pro-industry measures Duty reduced to 2% from 5% on 2000 items, mostly plant and machinery import
Tax credit on employment generation by new industrial undertaking increased to 2% from 1%
Tax credit for making over 90% sales to registered persons increased to 3% from 2.5%
20% tax credit on investment for BMR via 100% new equity financing for 5yrs extended to Jun-19
100% tax credit on new industry & expansion through equity threshold reduced to 70% from 100% & extended to Jun-
19
Period of exemption on investment in green-field industrial undertakings extended to Jun-19
30% RD on import of Bead Wire used in tyres manufacture abolished
CD on cement clinker, and semi-printed paper etc. increased to protect local industry
Privatization target of PRs50bn
Source: Budget Documents, KASB research
4. Page 4
Pakistan Strategy – June 2016
#2: Incentives to improve export potential; limited near-term boost
Notwithstanding the global economy slowdown including demand slowdown in China, we
believe pro-textile measures (including further reduction in export refinance rate and GST
refunds) as well as zero-rating restoration for all five export-oriented sectors should help ease
cash flows, finance working capital needs, and improve export potential. Some focus on
facilitation of non-traditional exports through setting up of technology upgradation fund is
welcome, though implementation and taking the plan efficiently forward is required to make
structural improvement and increase the country’s export competitiveness. Near-term drag on
exports, however, is expected to remain, given global environment and overvalued exchange
rate.
#3: Fiscal consolidation
The government’s resolve to reduce fiscal deficit to 11-yr low of 3.8% of GDP in FY17 from
4.3% of GDP, is a formidable task in our view, given hefty development spending allocations,
ambitious target of 39% reduction in power subsidies, and potential shortfall in non-tax
revenue stream.
Tax target more realistic: FBR’s tax revenue target of PRs3.6tn (16.7% YoY growth) seems
realistic vs above-20% YoY growth targets set in last few years. Key taxation measures
include withdrawal of exemptions and concessions (PRs120bn impact) and increase in
advance tax on non-filers in different areas.
Non-tax revenues are also expected to grow by 5% YoY to PRs960bn (+5% YoY) despite
remaining flat in FY16. We highlight uncertainty under few heads including (1) PRs170bn
(US$1.5bn) under coalition support fund vs only US$0.9bn received FY16 to date – where the
Finance Minister hinted at a new arrangement being worked upon with US government, and
(2) PRs75bn from 3G/4G license auction.
In order to meet the fiscal deficit target of 3.8% of GDP, current expenditures are targeted to
grow by only 4% vs 22% growth projected for development outlay. The govt. also expects
provinces to turn in a surplus of PRs339bn (1% of GDP), despite a hefty provincial PSDP
target (up 19% to PRs875bn).
Chart 2: Curtailing twin deficits as % of GDP will likely be a challenge
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
FY10
FY11
FY12
FY13
FY14
FY15
FY16E
FY17E
Fiscal deficit/GDP Current account deficit/GDP
Source: Economic Survey, Budget in Brief FY16
Chart 3: Debt/GDP to be brought <60% in next 2-yrs from 64.8% in FY16
48%
50%
52%
54%
56%
58%
60%
62%
64%
66%
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17B
FY18B
FY19B
Source: Economic Survey, Budget in Brief FY16
5. Page 5
Pakistan Strategy – June 2016
Table 5: Key budgetary targets
(PRsbn) FY16R FY17B YoY Comments
Total Revenue
(1+2)
4,333 4,916 13% Mainly via withdrawal of tax exemptions and concessions (PRs120bn impact) and FED hikes
% of GDP 14.6% 14.7%
(1)Tax Revenue 3,420 3,956 16% FBR collection target is PRs3,621bn, implying a realistic 16.7% YoY growth
Direct tax 1,324 1,558 18% Extension in Super tax, Higher tax rate on non-filers, tax on property gross income, builders & developers etc.
Indirect tax 1,780 2,063 16% Withdrawal of concessions & exemptions, FED hike on cement, cigarettes and GST on steel, POL products etc.
Other taxes 316 335 6%
GIDC target unchanged (PRs145bn), Petroleum levy collection target (up 11% to PRs150bn), in line with expected
growth in fuel sales
(2) Non tax revenue 913 960 5% Downside risk from planned PTA profits of PRs75bn (3G/4G auction) & Coalition support fund (US$1.5bn)
Transfer to prov. 1,852 2,136 15% Higher revenue transfer based on NFC Award
Total Expenditure
(1+2)
4,096 4,395 7% PSDP allocation increased while current expenditure to grow by meager 4% (Risk of upside in current exp)
% of GDP 13.8% 13.1%
(1) Current Exp 3,282 3,400 4%
Realignment by reducing subsidy by 39% to pay for 3% higher debt servicing (PRs1.36trn) & defence spend
(+11%)
General services 2,559 2,707 6% 7.7% higher minimum wage, for civil servants, hike in minimum pension
Subsidies 197 141 -28% Mainly through reduction of power sector subsidy by 39% to PRs 118bn
Defence 776 860 11% A normalized 10-11% increase is expected unless there is further uptick in security operations
(2) Development 814 995 22% Likely to face the axe in case of slippages in current expenditure targets
Federal PSDP 661 800 21%
Allocation for National Highway (PRs188bn), power sector (PRs130bn), new gas development fund (PRs25bn) to
supply gas to remote areas
Provincial PSDP 732 875 19% Pressure of surplus balance could lead to cuts
Other 128 157 23% BISP up 13% to PRs115bn, while PRs6bn allocated under trade policy incentives
Provincial surplus 337 339 1% Based on higher revenue transfers, we await provincial budgets announcement to comment further
Consolidated
deficit
-1,278 -1,276 0% Highly dependent on effective implementation of subsidy elimination & revenue targets
% of GDP -4.3% -3.8%
Source: MoF, KASB
R= Revised; B=Budgeted
Chart 4: Planned rise in Tax/GDP from 12.6% to 12.9% in FY17E
52.0%
54.0%
56.0%
58.0%
60.0%
62.0%
64.0%
66.0%
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16B
FY17B
Source: MoF, Budget in Brief FY16
Chart 5: PSDP breakup (PRsbn)*
Transport ,
229
IDPs, 100
Power, 157
32
Gas , 25
HEC, 21
National
Health, 35
Others, 201
*Federal Portion only
Source: Budget in Brief FY16
6. Page 6
Pakistan Strategy – June 2016
Financing of the deficit: The budgeted PRs50bn under privatization proceeds indicate
renewed commitment towards the strategic sale of state-owned enterprises, which hit a snag
in FY16. Plans to finance the deficit point towards much greater reliance on domestic
financing (where share of bank borrowing is projected to increase to 35% from 16% of the
total deficit) compared to much lower 18% share of external financing vs 36% in FY16. This is
mainly due to a jump in external loan repayments in FY17 to PRs585bn (US$5.5bn) from
PRs395bn (US$3.8bn) in FY16. However, the plan to tap the global capital market remains
on the table, whereby the government has targeted PRs106bn (US$1bn) Eurobond issue
coupled with Rs79bn (US$750mn) Sukuk bond. The government also expects US$2bn loan
from a consortium of commercial banks. The total public debt/GDP is projected to be reduced
to 61.4% in FY17 vs 64.8% in FY16E, where external debt/GDP has gradually been declining
of late (at 23.6% in Mar-16 from 24.1% in FY14).
#4-Government persists on documentation drive
As part of its drive to broaden tax net, the government has persisted on its drive to increase
the cost of not paying the taxes by building on the measures for increased documentation
announced last year. Following points are noteworthy;
• Not only has the government increased the distinction for tax-filers and non-tax
filers, the scope of the scheme has been further broadened, to include capital
markets (mutual fund investment, capital gains, and dividend income), insurance,
autos and other sectors. As per media reports, the government has covered 30 new
areas in the budget where the distinction due to higher withholding tax has been
introduced.
• Despite opposition from the traders and retailers, the government has persisted on
imposition of 0.6% Withholding Tax on banking transaction exceeding PRs50,000 for
non-filers. The introduction of this measure last year resulted in disintermediation for
banks at a limited scale. The government has shown flexibility by introducing an
amnesty scheme which failed to produce the desired results as only 10,000 new tax
filers availed the benefits under the scheme. We expect the traders, wholesalers and
retailers, the three segments which feel the pain of higher tax due to heavy reliance
on banking channels, to return to negotiating table on this issue.
Chart 8: Planned rise in Tax/GDP from
12.6% to 12.9% in FY17E, &16.1% in FY19E
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16R
FY17B
FY18B
FY19B
Source: MoF
Chart 6: Banks are expected to finance PRs458bn (35% of total) in FY17
-500
0
500
1000
1500
2000
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16R
FY17B
External Bank borrowing Non-bank Privatization
Source: MoF, Budget in Brief FY16
Chart 7: Realistic growth build-in for direct taxes collection (PRsbn)
0%
10%
20%
30%
40%
50%
60%
FY11
FY12
FY13
FY14
FY15
FY16R
FY17B
Direct tax Indirect tax
Source: Budget in Brief FY16
7. Page 7
Pakistan Strategy – June 2016
• Three main segments of economy-agriculture, services, and real estate largely
remains outside the tax ambit .The introduction of fixed area-based tax on real
estate builders and developers is likely to be passed on to buyers and may not
capture the income of the entities involved in the activities.
#5-Corporate earnings: encouraging backdrop for medium-
term growth
We eye limited near-term impact on corporate earnings from announced budget measures.
The extension in Super Tax for one more year will likely chip off earnings by 4-5% for
CY16/FY16. We project corporate earnings to decline 2% in CY16 and grow by 10% in CY17.
Beyond the impact of Super Tax, we contend FY17 Budget has laid down an encouraging
policy backdrop for the corporate earnings growth over the medium-term. Key elements in the
policy that particularly interest us are (1) a much-needed policy focus on agriculture, and
export, (2) a number of incentives for investment, and (3) continuation of heavy development
spending program. We believe future measures effectively remove potential areas of earnings
downside and set the stage for potential earnings surprises ahead, in our view. Overall
measures contained in the Budget reinforce our positive outlook on cement (infrastructure &
investment focus), select fertilizer (pro agri), autos (pro-agri), and IPPs (energy subsidy).
Budget is largely a non-event for E&P and Oil & Gas stocks (except for drag on earnings from
Super Tax) and banks (no major surprise). Sectors where the budget measures may have
negative impact on margins or bottom-line are Steel, Insurance and consumer.
.
Market reaction: Budget increases our liking
Despite disappointment on not seeing many of proposals of Pakistan Stock Exchange in the
FY17 budget, we believe a pro-agriculture and pro-export budget is likely to draw a positive
reaction from the market. A 3% performance of the market in one-week ahead of the budget
reflects market anticipation on the potential budgetary measures. With no major negative
surprise in the budget and largely positive outlook for corporate earnings growth, we believe
market valuation (CY16E P/E of 9.4x and D/Y of 5.9%) have further room for expansion. That
said, with budget out of way, we believe market focus will entirely shift to upcoming MSCI
decision on potential reclassification of Pakistan from MSCI Frontier Market to MSCI
Emerging Market. The decision, due on 14th
June, may complement the market excitement
on the budget and lead to sustained period of heightened activity.
Chart 9: KASB Universe Corporate Earning Growth (%) – 2005 - 2016E
‐20.0%
‐10.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2016
Source: KASB Research
Chart 10: Sectors Growth (CY15E –CY16E)
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
Chemical
Consumers
Cement
KSE-100
Power
Autos
Textiles
Fertilizer
Banks
Telecom
OilandGas
2016 2017
Source: KASB Research
8. Page 8
Pakistan Strategy – June 2016
Direct measures for the market
Changes in Capital Gains Tax- The government has continued to tinker with the capital gain
tax structure in the Budget-FY17. However, unlike last year, the changes are not drastic and
should be easily acceptable to market participants, in our view. Many of the pre-budget
proposals given by the Pakistan Stock Exchange have failed to find any favor in this budget.
We don’t expect any major disappointment among investors as expectations were not running
high on potential materialization of proposal. Meanwhile, higher tax rate on dividend income
has not materialized. Key measures from the market perspective are enumerated below.
The government has made two major changes in CGT and dividend tax regimes. Firstly, the
exemption from tax on capital gains arising from securities with holding period of more than
48-mths has been withdrawn and a flat tax rate for holding period beyond 48-mths has been
introduced at 7.5%. Secondly, distinctions for filers and non-filers have been introduced for
both CGT and tax on dividend. Following table details the new tax regime.
Table 6: Capital Gains Tax on Disposal of Securities (%)
*Holding Period FY11 FY12 FY13 FY14 FY15 FY16 FY17
Filers 10.0% 10.0% 10.0% 10.0% 12.5% 15.0% 15.0%
<6 Months
Non-Filers 18%
Filers 7.5% 8.0% 8.0% 8.0% 12.5% 15.0% 15.0%
6 Months - 1 Year
Non-Filers 18%
Filers - - - - 10.0% 12.5% 12.5%
1 Year - 2 Years
Non-Filers 16%
Filers - - - - - 7.5% 7.5%
2 Years - 4 Years
Non-Filers 11%
Filers - - - - - - 7.5%
> 4 Years
Non-Filers 11%
Source: Finance Bill
Super Tax extended: The government has extended the applicability of Super Tax for one
more year as hinted by the Finance Minister well ahead of Budget announcement. Just to
recall, the amount collected in Super Tax, levied at 3/4% of non-banking and banking
companies, will be used for the rehabilitation of Internally Displaced Persons (IDPs) due to
ongoing security operation. The Super Tax will drag corporate earnings by 4-5%. The scope
of Super Tax encompasses all sectors, including E&Ps, IPPs and Textile. Importantly, the
Chart 11 : KASB Universe Corporate Earning Growth (%) – 2005 - 2016E
Jan‐05
Jan‐06
Jan‐07
Jan‐08
Jan‐09
Jan‐10
Jan‐11
Jan‐12
Jan‐13
Jan‐14
Jan‐15
Jan‐16
6
8
10
12
Price
Source: KASB Research
Chart 12 : KSE100 Index Performance
‐
100
200
300
400
500
600
700
800
900
10,000
15,000
20,000
25,000
30,000
35,000
40,000
Jan‐13
Mar‐13
May‐13
Jun‐13
Aug‐13
Oct‐13
Dec‐13
Feb‐14
Apr‐14
Jun‐14
Aug‐14
Oct‐14
Dec‐14
Feb‐15
Apr‐15
Jun‐15
Aug‐15
Oct‐15
Dec‐15
Feb‐16
Apr‐16
Jun‐16
Vol (shrsmn) (rhs) KSE100 Index
Source: KASB Research
9. Page 9
Pakistan Strategy – June 2016
new tax will be applicable on tax year 2016, which suggests the required adjustment has to
be made in Jun-16 earnings.
Uniform tax for insurance sector: From market perspective, the changes in the tax
treatment of capital gains and dividend income can have implications for liquidity flows from
banks, a significant player in the stock market. The changes (fully explained below) have
reduced relative attractiveness of equity asset class for banks. This is particularly important
for banks’ investment in IPPs, in which returns are primarily contingent on dividend
distribution. Interestingly, dividend income on IPPs is taxed at 7.5% vs 10% for other sources.
It remains to be seen if the increase in CGT to 35% across various holding period will be
applicable on past capital gains.
Tax incentives for enlistment: The government has ignored the long-standing demand of
bourses of creating a permanent tax differential for listed and unlisted companies in order to
attract more listing and deepening of equity market. However, demand for extension in period
for tax credit has been met with 20% tax credit now available for two years (earlier: one year)
Withholding tax on dividend increased for non-filers: Withholding tax on dividend
distribution is proposed at 20% (earlier 17.5%) for non-filer. Meanwhile, the government has
introduced separate slabs for capital gain tax on non-filers (see above). We believe the
measure is likely to produce initial jitters among investors however the increase in tax is
unlikely to detract investors from stock market.
Revision in corporate tax rate to 31%: The revision is part of scheduled reduction in
corporate tax rate to 30% by 2018 and as such, built in our estimates.
FED removed on stock trading; withholding tax increased: The government has
streamlined taxation on stock trading and has provided exception from Federal Excise Duty
as the provincial government has already imposed 14% sales tax on such financial services.
The measure provides clarity on the double taxation though there will be no impact on the
transaction cost as only sales tax has been built into share trading cost. In a related
development, the withholding taxes on share trading has been increased to 0.02% from
0.01% levied on value of share trading .This will have a nominal impact on share trading cost.
Three key areas of criticism
1. An apparent focus on conventional areas for tax collection while untapped areas (real
estate, services and agriculture) are still outside the tax ambit despite few measures
announced in the budget.
2. Some of the tax measures for real estate and services sectors announced in the budget
may fan friction between provinces and the federal government, as provinces claim
authority in these areas under 18th Amendment.
3. Political noise on allocation of development spending in different provinces.
11. Page 11
Pakistan Strategy – June 2016
Cements: Pro-growth measures
Budget Impact: Positive
Losers: None, Winners: All
PSDP allocation up 20%
The government has jacked up its FY17 target for development spending by 20% to
PRs1.675trn (Federal component: PRs800bn, up 21% YoY against revised FY16 target of
PRs661bn) as progress on many projects under CPEC accelerates. We believe, the higher
PSDP, largely dominated by infrastructure and construction projects will set the stage for yet
another year of strong double-digit growth in cement off-take amid stable demand, pricing and
investment outlook in the sector. However, fiscal pressure, given a lower deficit target of
3.8%, might keep the actual disbursements in check.
FED increased from 5% on MRP to PRs50/bag
FED calculation mechanism for levying tax on cement has been changed from 5% of the
retail price (PRs25-27/bag) to a fixed rate of PRs50/bag. We believe cement companies will
be able to comfortably pass-on the impact of higher FED to end consumers (net impact on
prices of 5-6%) and hence will not hurt cement industry profitability.
Custom duty on coal has been reduced; raised for clinker
The custom duty on import of coal has been reduced to 5% reversing the 1% increase in the
duty (as levied in the mini-budget). This reduction in import duty will lead to coal import being
categorized under the revised slab of 3% (as 2% and 5% slabs merged to one slab of 3%).
Our crude estimates show a muted impact of 0.2-0.6% in primary margins for the industry.
Moreover, the duty on import of clinker has been raised from 2% to 11%; which will not have
any material impact for the industry, in our view, given minimal clinker imports.
3% Super tax
Super tax of 3%, levied in FY15 as a one-time tax, has now been extended and will be levied
for FY16 as well; however, the only change this time will be the exclusion of depreciation and
carry forward tax losses for the purpose of tax calculation.
Inter-corporate dividends will now be subject to taxes
The benefit of group taxation relief is proposed to be restricted to percentage of holding
whereby the subsidiary will now be able to surrender its assessed losses to the parent
company only up to the percentage of its holding in the company. The exemption from inter-
corporate dividend taxation for companies exercising group relief will also be withdrawn. We
believe LUCK and DGKC will face the brunt of the same amongst KASB cement universe.
Incentives for capital investment
The government has announced several measures to promote capital investments, including:
(1) extension in BMR tax credit facility from FY16 to FY19, (2) the condition of100% fresh
equity for claiming tax credit on expansion of existing plant has been reduced to at least 70%
equity, while the timeline for the same has also been extended from FY16 to FY19, and (3)
exemption on investment in green-field industrial undertakings has also been extended up to
FY19.
Other measures
In some other pro-infrastructure development measures, government has enhanced the limit
of mark-up on house building and export refinancing rate has been reduced to 3% from 3.5%
earlier, which will provide boost to private infrastructure activity, in our view. On a rather
negative side, a separate tax regime for Developers of plots and Builders of residential,
commercial and other buildings has been proposed, whereby tax will be charged on the basis
of geography and size of plot.
12. Page 12
Pakistan Strategy – June 2016
Fertilizers – A number of incentives to improve off-
take in FY17
Budget Impact: Positive
Losers: None, Winner: Engro, Efert, FFC, FFBL, Fatima and AGL
Budgetary proposals for the upcoming fiscal year are designed to provide respite to the
farmer through lower input costs and higher liquidity. Reduction in the prices of fertilizers and
pesticides through reduction in GST and enhanced availability of credit would positively affect
demand for fertilizers in FY17, in our view. We expect the volumetric growth to lead to a
substantial reduction in current inventory levels of urea and improve earnings of the
manufacturers. As per our calculations, fertilizers will have to reduce prices by PRs50/bag,
which will negatively affect their margins on urea and DAP. However, once the GST and
subsidy is effective, the improvement in off-take will positively affect the profitability of the
players due to reduction in inventory levels. On the basis of relatively better margins on
concessionary gas, we are selective in our liking for EFERT, FATIMA and ENGRO.
Reduction in GST + subsidy disbursement to lead to reduction in urea and DAP
prices
The govt. has announced reduction in urea prices from current prevailing levels to
PRs1400/bag for the farmers. We believe the manufacturers will bear PRs50/bag reduction in
urea prices from ex-factory prices of PRs1750/bag. The remaining differential between urea
prices of PRs1740/bag (incl. dealer margin) and the targeted PRs1400/bag would be
achieved through GST reduction of 12% and subsidy of ~PRs13.2bn. As per our calculations,
(1) the reduction in GST would reduce farmer prices to PRs1566/bag, which translates into
federal govt. burden of PRs14bn on 4mn tons off-take, and (2) subsidy of PRs13bn would
reduce farmer prices further to PRs1400/bag. The retention prices of manufacturers are
expected to decline by PRs35/bag. Improved demand would reduce domestic inventory,
which was hovering around ~1.45mn tons at the end of May-16. However, considering the
fact that the GST and subsidy are effective from 1’Jul-16, we might observe a further increase
in inventory levels in Jun-16 before they start decreasing.
In case of DAP, a subsidy of ~PRs10bn has been allocated. This will lead to decline in prices
of PRs250/bag on offtake of 2mn tons in FY17. However, manufacturers will also curtail
prices by PRs50/bag. We believe the subsidy and price cut would bring farmer prices to
~PRs2500-2700/bag which would be positive for importers (including Efert) and FFBL due to
the strong demand and differential in landed cost and domestic prices.
Other concessions to boost outlook further
We believe additional measures such as elimination of GST on pesticides, subsidy on
electricity used by tube wells and higher credit availability serve as an icing on the cake for
the farmers. These measures would further improve farming conditions.
Super-tax to negatively impact earnings in CY16
We believe imposition of super tax of 3% would negatively impact the earnings of the
manufacturers in CY16. Since profitability has been affected by high inventory levels in the
last couple of quarters and is expected to be weak in 2Q16 as well on account of the same,
we believe the impact of super tax would not be as strong as in CY15. After assuming a low
off-take for Jun-16, our calculations suggest an EPS impact of PRs0.45/0.20/0.35/0.15 for
FFC/FFBL/Efert/Fatima.
13. Page 13
Pakistan Strategy – June 2016
Textile – No-tax no refund a major relief
Budget Impact: Positive
Losers: None, Winners: All textile exporters
Extension of relief measures: Extension of relief measures announced in the last budget
like reduced Export Refinance Rates, continuation of duty drawback at various rates on textile
products, and exemption of CD on import of machinery bode well for textile sector.
Long-standing demand met: The government has yielded a major, long-standing demand
of textile and other export-oriented sectors and levied no-tax, no-refund policy (zero rating of
textile exports). The measure will allow textile companies to pay no GST at the time of import
or local sourcing of raw material and energy fuels hence, relieving the sector from the hassle
of going through the GST refund process. Local sales of textile goods will continue to be
taxed at 5%.
Stuck-up claims to be cleared: Furthermore, the government has promised to refund stuck-
up GST claims by Aug-16. The total stuck-up claims of textile industry are quoted at PRs49bn
(total refund claims of PRs110bn).
Direct benefit to earnings: The simplification of tax process on raw material and energy
consumption will result in direct relief on balance sheet (reduced working capital, hence low
borrowing) and profit (reduced financial charges). Nishat Mills and Nishat Chunian Ltd carry
PRs1.2bn and PRs0.7bn as refund claims from the government as of Jun-15. For the two
companies, the zero-rating could bring PRs0.18/sh and PRs0.17/sh relief on earnings.
Zero rating is open to misuse: Contrary to pre-budget expectation, the government has not
reduced the levy on gas (Gas Infrastructure Development Cess) or promised any major
benefit in the form of rebate on foreign exchange on early surrender of export proceeds. The
zero-rating regime is susceptible to misuse as seen in the past. It remains to be seen what
safeguard measures the tax authorities will enforce to avoid misuse.
OMCs: Non-event
Budget Impact: Neutral
Losers: None, Winners: APL
Power subsidy reduction can solve issues, albeit timeline is uncertain
Budget 2016-17 does not carry any specific major impacting the downstream sector. As
details on fiscal account suggest, expectation regarding any settlement of stuck-up
receivables have once again failed to materialize. Government plans to reduce power sector
subsidy by another 39% in this year, with major change coming from subsidy reduction for
Karachi Electric Consumers.
Duty slabs increased for petrol and diesel: The changes in the duty slabs will impact the
ex-refinery prices of diesel, petrol and furnace oil. Custom duty on diesel has been increased
to 11% from 10% while CD on petrol will see 1% increase to 3%. Custom duty on furnace oil
is likely to reduce to 3% from 5%. The changes in duty slabs will not impact the margins of
OMCs. We do not see any reason for the government to lift Deemed Duty on diesel for
refineries.
LNG imports likely to ramp-up: Completion of power projects by Dec-16 may see increase
in LNG imports by PSO to 60 cargos (4.5mn ton per annum) from current 48 cargos (3.9mn
ton), up 25% which may benefit PSO.
Government has increased allocation for transportation infrastructure, including projects for
China Pakistan Economic Corridor, to PRs188bn in Budget2016-17. Among the listed
companies, Attock Petroleum Ltd (APL) may benefit from increased bitumen demand which is
used in road construction.
14. Page 14
Pakistan Strategy – June 2016
Power – Focus remains on new capacity
Budget Impact: Neutral
Losers: None, Winners: None
Emphasis on boosting investments in new plants
We view the FY17 budget to be neutral for the power sector. The addition of power
generation capacity continues to remain the major focus for the government with: (1) 16%
higher PSDP allocation of PRs130bn as compared to PRs112bn last year for energy sector,
(2) reduced subsidy burden (down 39% YoY), and (3) planned addition of 10,000MW
electricity to the national grid by Mar-18. Moreover, beyond that Dasu, Diamer-Bhasha,
Karachi Civil Nuclear Energy and many other projects are in the pipeline including coal-based
power projects under CPEC. Reduced subsidy burden and focus on increasing transmission
and distribution network coupled with addition of electricity generation capacity bode well for
the sector. However, the government has stopped short of announcing any framework for
reducing the existing stock of circular debt. The imposition of super tax will also be applicable
on IPPs, in our view.
Banks – Barred from any specific measures
Budget Impact: Neutral
Winners: None; Losers: None
Unlike last year, this year’s budget has proved to be largely neutral for the banking sector as
no major specific measure has been announced. The imposition of 4% super tax on bank’s
earnings will likely chip off bank’s earnings by 6.1% in CY16. The government’s drive to
broaden the tax net via increasing cost of non-compliance in the form of withholding tax on
banking transaction or cash withdrawal may impact bank’s asset growth, and deposit mix.
However, the impact of the same was quite limited last year. The FY17 budget is unlikely to
have any major bearing on energy and food prices and should be termed as non-inflationary.
The macro backdrop for the banks continues to improve as the government now targets
higher GDP growth. Government’s focus on agriculture and promoting investment bodes well
for banking sector advances and may provide a much-needed avenue for placement of
assets over the medium-term. The government targets to raise PRs453bn funds from banks
for deficit financing target which may account for up to ~43% of likely asset growth in FY17;
hence, the need to grow advances to place expected asset addition remains.
E&Ps –Super Tax drag continue even in low earnings year
Budget Impact: Neutral
Losers: NA, Winner NA
The details in the relevant section of the proposed Act suggest that the Super Tax will also be
applicable on E&Ps. We estimate negative earnings impact for OGDC, PPL, POL and Mari of
4-5% for FY16E.
Power sector reform remains important for providing certainty on cash flow outlook of both
OGDC and PPL. The projected reduction in power subsidy by 33% is significant and if
materialized can provide further relief to E&P companies from circular debt.
We maintain our overweight stance on E&Ps sector with Buy rating on all four E&P
companies.
15. Page 15
Pakistan Strategy – June 2016
Autos – Largely a non-event
Budget Impact: Neutral
Losers: None, Winner: None
As expected the long term auto policy recommendations have been incorporated in the FY17
budget. The implementation of the auto policy is positive in terms of reduced CKD duty and
favorable environment for new entrants. We highlight that absence of any proposal on
relaxation in used cars’ import policy comes in as a relief, whereby used cars imports
continue to be on the rise, growing by 65% YoY to 41,507units in 10MFY16. We believe
extension of the pro-agri measures are likely to have positive spillover on auto industry sales
driven by potentially higher rural demand.
Advance tax on non-filers at the time of auto-financing
We believe the proposal of 3% advance tax to be collected by the financial institutions at the
time of financing/leasing of the vehicle could be slightly negative for financing-backed sales
(approx. 35%-40% of total industry sales). The auto sales through consumer financing have
seen significant increase in the past 2-years (reportedly from 10-20%) on the back of low
interest rates and new auto-financing products introduced by banks. However, several pro-
agriculture income measures suggest demand from rural areas should gain traction in FY17.
Non-event for tractors
The budget is largely a non-event for tractor industry, with no change in GST or CBU duties.
Recall tractor sales have jumped 37% YoY in 10MFY15, post reduction in GST from 17% to
10% in previous budget.
Good news for tyre manufacturers
Removal of 10% regulatory duty on import of bead wire, used should be positive for tyre
manufacturers (GTYR).
Chemicals – Lower custom duty to benefit margin
Budget Impact: Neutral
Losers: None, Winners: ICI
Lower custom duty on coal and MEG
The reduction in the Custom duty slabs is expected to reduce the CD on thermal coal to 3%
from 6% last year. Duty on PTA, a major feedstock for polyester, will also be reduced to 3%
from 4% previously. Post commissioning of two additional coal boilers at the start of FY17,
coal has become one of the major sources of fuel for ICI. Therefore the earnings impact for
ICI will be fairly modest and should provide some relief to its ailing PSF segment, in our view.
Consumers – adverse taxation changes
Budget Impact: Negative
Losers: Nestle, Efoods, Nurpur and Shakargunj, Winners: None
Removal of zero-rating would make dairy firms unable to claim refunds on GST paid on inputs
(except on infant use products). Perhaps in anticipation of this measure, dairy producers had
already passed on the impact to final consumers by increasing prices before the budget by
PRs5/ltr. However, we believe the firms have not yet accounted for the impact of imposition of
regulatory duty on powdered milk. Thus, the prices of brands such as Everyday and Tarang
may be increase post budget. Any strategy by major players such as Efoods and Nestle will
be undertaken after understanding the implications of higher prices on volumetric growth of
the brands. Overall, we expect either margins or volume to be negatively affected by these
measures.
Chart 13: Advances for auto-financing (PRs
bn) have doubled in the past 3 years.
-
20
40
60
80
100
120
Sept-12
Dec-12
Mar-13
June-13
Sept-13
Dec-13
Mar-14
June-145
Sept-14
Dec-14
Mar-15
June-15
Sept-15
Dec-15
Mar-16
Source: MoF
16. Page 16
Pakistan Strategy – June 2016
FED raised on cigarettes and beverages further
The govt. has proposed to increase FED on cigarettes and carbonated water (beverages)
further. For carbonated water FED has been proposed to be increased to 11.5% from the
prevailing 10.5%. On cigarettes the new rates will be as follows: for prices greater than
PRs3,435/1,000 cigarettes, the revised rate is PRs3,705/1000 cigarettes and for prices
greater than PRs1,534/1000 cigarettes, the revised rate is PRs1,649/1000 cigarettes.
Relief on CD on machinery
The govt. has proposed reduction in CD on cool chain machinery from 5% to 3%. The
measure will be positive for companies engaged in meat processing such as Al-Shaheer
Corporation and FFBL. Furthermore, it has also been proposed to reduce CD on machinery
used in dairy, livestock, fish farming and poultry sectors from 5% to 2% which is good for
investments in these sectors. CD has also been proposed to be removed on fish and shrimp
feed.
Steels Melters– Size of GST increase to decide the EPS drag
Budget Impact: Negative
Losers: All, Winners: None
We see the FY17 budget to have negative impact on the steel sector, where positives
emanating from higher PSDP allocation and lower custom duty (CD) on billets will be offset
by the negative impact from higher CD on scrap and higher GST.
PSDP allocated at PRs1.675bn, up 20%YoY: We highlight that the handsome PSDP
allocation (PRs1.675bn up 20%) including heavy infrastructure and development projects
coupled with CPEC, will continue to provide major impetus for steel demand growth going
forward.
Customs duty on billets & scrap: As per the FY17 budget, the government has merged CD
slabs of 2% and 5% into one slab of 3%. The development will increase the CD on imported
scrap to 3% from 2% earlier, which will increase cost of producing billets by PRs300-350/ton
for steel melters. However, the development will reduce the CD on imported billets and Hot-
rolled coil to 3% from 6% previously, resulting in PRs1000-1100/ton savings for flat rolled
players (International steel Ltd and Aisha steel) and long rolled steel re-rollers (Mughal & Dost
steel) directly importing billets rather than producing internally.
Enhanced fixed rate basis GST: The government has hinted to enhance the fixed rate basis
sales tax for steel-melters and re-rollers. Long-rolled steel producers currently pay a fixed rate
basis sales tax of PRs9 for each unit of electricity consumed. Although the increase in the
rate is yet not clear we highlight a potential impact of PRs800-850/ton for long-rolled steel
producers for each PRs1/unit increase in GST.
Insurance– axe falls on capital gains and dividend income
Budget Impact: Negative
Winners: None; Losers: all
The increase in tax rate for dividend income and capital gains will likely hurt earnings of both
life and general insurance companies. Based on dividend income and capital gains booked in
2015, we estimate the impact of 10%-15% for Adamjee, New Jubilee Insurance and New
Jubilee Life insurance. The government has announced a number of areas for tax credit for
life/health insurance. Similarly, the finance minister has announced to start health insurance
policy for poor and lower income with target of PRs9bn premium in 2016-17. Both the
measures will have positive impact on industry growth.
17. Page 17
Pakistan Strategy – June 2016
Analyst Certification
I, Mohammad Fawad Khan,CFA 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.
Fundamental equity opinion key
Investment rating Total return expectation (within 12-month period of date of initial rating)
Buy ≥ 20%
Neutral ≥ 0%
Underperform N/A
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18. Page 18
Pakistan Strategy – June 2016
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