BR Research Newsletter

Inside this:
Breaking Dars optimism
Privatising discos

ANALYSES & COMMENTS BY

BR RESEARCH

Government securities on bourse

Mutual funds better or worse?

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Monday, January 06, 2014| BR Research Newsletter |

BR Research Newsletter

Breaking Dars optimism

questionable as 2.2 percent (Rs570 bn) does not match with the incremental debt of
Rs1.1 trillion in the first quarter. Economists smell that some smart accounting gimmick
by the MoF may have done the trick. Then the mentioned increase of 1,700 MW of

The gist of Ishaq Dars presentation to parliament members and media last week is to

power generation in the national grid seems to be a highly inflated number. The

boost confidence amongst the stakeholders on the state of the economy. Its a step

reason is simple that, at the margin, increase is attributed to more usage of furnace

in the right direction but had the minister invited a few economists as well, facts and

oil and that also explained low load shedding. However, the increase in consumption

forecasts narrated could have been well contested. Analysts and economists alike

of furnace oil (both domestic production and imports) is only 5 percent and it

are casting doubts on a few of his tall claims. That said, they all are appraising much

accounts for 40 percent of power generation.

better efforts put by this government in resolving economic woes.

Hence, increase in generation is only two percent which is about 500 MW not 1700
Some economic fundamentals were already improving by the time PML-N

MW. In fact, if one goes about the latest number released by the governments own

government took over as average CPI was 6.5 percent for Jan-Jun 13 and it

NTDC, it reveals the power generation has dropped significantly over the months.

increased to 8.9 percent for the first six months of this government. So its not fair to

From a generation of 13310 MW in July last year, it had touched a low of 9467 MW in

compare last five years average inflation of 12 percent.

November keeping the shortfall over 2000 MW even in the winters. So much for

The taxto-GDP ratio and fiscal deficit numbers shown for the last year have factual

capacity addition and clearing circular debt!

errors tax-to-GDP of 8.5 percent mentioned was mere FBRs revenue. Fiscal deficit

Then the more usage of furnace oil has increased the cost and in consequence

for last year was not only marginally overstated but was also high owing to an

losses to Discos. That is why circular debt has emerged again at a faster pace and

accounting treatment to include the part of circular debt adjustments in the last

government has already paid over hundreds of billion rupees in power related

year.

subsidies despite major tariff rationalisation.

It is also mentioned that public debt increased from Rs6 trillion to 14.4 trillion during

The number shown on issuance of currency notes of Rs206 billion in first five months

2008-13 period. But it somehow missed to narrate the alarming increase of Rs1.1

does not really show the real impact of monetization. The data while shown on

trillion of public debt in the first quarter this very fiscal year. Mind you, first quarter

governments borrowings impact on reserve money is much higher - Rs617 billion

piling of debt is two third of last full years incremental debt. There has to be a

which has a proven money multiplier affect and has inflationary consequences.

rationale for hiking debt and there should be some workable plan to service it.
On the growth front, the government is excited about the 6.8 percent growth in LSM
Yes, the government has done a commendable job curtailing the current
expenditure. Although, austerity paid off, in terms of lowering fiscal deficit, it is
2 | BR Research Newsletter | Monday, January 06, 2014

during first quarter and is crediting it upon improved power supply situation. However,

BR Research Newsletter
deciphering this data depicts a different picture. The sector to be benefited most by

Being an optimist, assuming 70 percent of this money to be flown in the actual

low load shedding is textile sector which grew by a mere 2 percent.

reserves situation would reduce to $8 billion. And by subtracting commercial banks

reserves, SBP liquid reserves would be less than $4 billion by December 14.

The major impetus of LSM emanated from fertilizer production which grew by 41
percent in the first quarter and that is owing to better gas availability. Its good to see
a bit of economic recovery, but, that selective growth was not able to generate
much employment as claimed. As for the GDP growth of 5 percent in the first
quarter, a detailed note was published has already been published earlier in these
columns...

The single most crucial element for economic recovery is balance of

payment and its projection stated by MoF is not only missing a few repayments but
also too optimist in forecasting inflows. The calculations do not make sense. From
todays reserves position of $8.4 billion, government expects addition of $10.1 billion
in the calendar year. Then its projected reserves situation by Dec 14, net of current
account deficit of $2.5 billion, is $16 billion.
Its wishful thinking as it significantly defies ground realities. It does not include the
international debt repayment, including IMF, of $3-3.5 billion. Then it understates the
CAD by at least $1.5 billion mind you CAD of Jul-Nov 13 is already $1.8 billion. Thus,
at least, $5 billion is wiped out of this forecast to leave the reserves strength at $11
billion. Then, the addition of $10.1 billion is pie in the sky stuff it includes $2 billion for
3G licenses and pending privatization proceeds and both are being budgeted every
year with zero inflows.
It also includes $2 billion from euro bond and remittances based floatation bond
analysts are of view that even if half of it comes it will be a big surprise given global
suppressed capital situation and falling credibility of Pakistan. Then its hard to get
Coalition Support Fund pending payments given the soaring Pak-US relations and the
list goes on.

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Interestingly, this is no different to a situation where we stand now!

BR Research Newsletter

Privatising discos
As the government intends to move forward with its privatisation drive, more and

is not saying that privatising discos would solve the problems in one go; there are
bottlenecks which needs to be addressed. Nepras role as a regulator has been
questioned often and rightly so, even by the Supreme Court.

more voices have started campaigning against it. And it is not just the popular

Yes, the regulator needs to be more efficient and independent, but that should not

media and political parties that are raising hue and cry, but others - the more

stop the process to move ahead. There is enough weight in empowering provinces

sensible of the lot such as academics - have also started raising concerns, where

with the responsibility, but that should not stretch to the management of discos. The

the KESC has been made as a reference case when talking about privatisation of

provinces, at present lack the capacity to manage discos, and it would be best

discos in Pakistan.

advised if they keep the ownership control and let someone else from the private

People have asked question whether KESCs privatisation has reaped dividends, and
whether the consumers of Karachi are better off. Surprisingly, some still believe that
KESC has miserably failed after privatisation, quoting observations of Senates
Standing Committee, headed by Senator Zahid Khan.
How do you term KESC a failure when it has since privatisation, added 1000 MW to its
generation, improved efficiency by 23 percent, reduced distribution loses from 36
percent to 27 percent in three years, invested over a billion dollar in capacity
enhancements, converted its plants on more efficient fuel, provided half the city
uninterrupted power supply? Maybe the critics know better, because surely the
numbers tell quite another tale.
Saying that privatising distribution companies would lead to them exploiting local
consumers by virtue of monopoly makes little sense. Time and again, it has been
proposed that privatised power distribution entities can work more efficiently like the
cellular network providers with a resident in Lahore having the option to chose
between Lesco and Fesco.
There is no end to pessimism if one refuses to buy the idea of privatisation on the
basis that since the regulator is corrupt; it would team up with the private player. This
4 | BR Research Newsletter | Monday, January 06, 2014

sector manage it.

BR Research Newsletter

Government securities on bourse

Regardless of the underlying motivation, the listing of risk-free securities on the KSE
(expectedly followed by LSE and ISE) appears to be the best step forward which will
not only broaden the horizons of government borrowings to include domestic retail
Finally the long-held objective of listing of government securities on the local bourses
has taken some steps forward. According to news reports, the operational process
will set-off from January 31.
Market participants have a diverse set of opinions on the development. Some
assume that the government is planning to borrow more in the coming times and
hence looking forward to broaden the investor-base. Others guess that the
government wants to reduce its reliance on the financial system in order for them to
facilitate the private sector.

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investor community most of which is currently unaware of this risk-free avenue but will
also entice foreign portfolio investments in fixed-income securities which is currently
only concentrated in equity.
Besides, diversified investors will result in better price discovery mechanism of the
government securities. It is also likely to trigger the development of KSEs bond
automated trading system (BATS) which is currently in its nascent phase as the listed
TFCs are not actively traded.

BR Research Newsletter
While most market participants hail the idea of listing of government securities, a little
dissent was found whereby some analysts believe that government securities will
gulp the share of retail investments from the equity market. However, that may not
be necessarily so.
Firstly, equity investors have an entirely different risk-profile than fixed-income
investors. So there is no motivation for a typical equity investor to drift towards lowyielding government papers just because they are risk-free. Although it might draw
attention of the risk-averse investors who desire to benefit from dividend-yields than
price fluctuations but such investors represent a small portion of the equity market
and those also turn towards mutual funds to maximize their returns.
Secondly, the broker commission is very nominal in case of fixed-income securities
and hence they dont push such products forward. Initially, the government
securities are expected to meet the same fate. Nevertheless, the risk-free fixedincome securities bear an enormous attraction for the small retail investors which can
be gauged by the tremendous growth achieved by National saving schemes (NSS)
despite having no secondary market. The process of government securities gaining
traction might be slow but it will surely make a success story.
It will not only reduce the reliance on authorised primary dealers but will also create
a level playing field for bank and non-banking participants to reap the avenue.
While it will not affect the equity investments, it will certainly bring-in more investors
which will add depth to the secondary market and will be an important milestone in
the establishment of bond market in the country.

6 | BR Research Newsletter | Monday, January 06, 2014

BR Research Newsletter

Mutual funds - better or worse?

This dip can be justified by analyzing the trend in discount rates over the period. 2012
started on a high interest rate regime when the average discount rate was about 11
percent. However, 2013 marked the regime of low interest rates, when the average
inflation dropped to 9.35 percent.
As the rates on fixed income instruments move in tandem with changes in discount
rates, decline in interest rates over the period pushed the rates on fixed income
instruments down and therefore the returns on fixed income funds.
Similarly, for asset allocation and balanced funds, preset allocation in fixed income
instruments took a toll on the performance of these funds as well.
While KSE-100 rallied to cross 25,000 level by the end of 2013, equity mutual funds
prospered as the average industry return increased by more than 300 bps to 49
percent in CY13, thus actively tracking the benchmark index which in contrast
mustered a return of 51 percent.

In case you are unaware, 15 equity funds from Pakistan were spotted in the list of top

Mutual funds under the fund of funds scheme appeared to have chased the

100 best performing equity funds in 2012, according to an analysis by Thomson

philosophy of picking up the right portfolio mix at the right time as the average

Reuters Lipper, who actively tracks managed mutual funds worldwide. The analysis

industry return for this category stacked up considerably from 21.65 percent to a

was based on a set of 27,153 actively managed equity mutual funds. But this was the

handsome 33.10 percent.

case last year, whether Pakistani mutual funds are on the same pace now is yet to
be disclosed.

With all eyes on upcoming monetary policy, where market participants expect SBP to
maintain the status quo, fixed income fund managers are endeavoring to raise the

Having faced a bright season last year, the fortune of fixed income mutual funds

duration of their portfolio to slash the impact of reval losses on their fund

dived downwards as average industry return for Income Funds which hovered

performance. As the equity market is anticipated to touch fresh highs in forthcoming

around 10 percent in CY12, narrowed down to 7.8 percent in CY13. The same

months, the performance of equity funds is anticipated to be better than CY13.

happened to money market funds whose returns plunged by nearly 215 basis points
to 8 percent in CY13.
7 | BR Research Newsletter | Monday, January 06, 2014