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Pakistan Economy: Upcoming PIB Auction & Implications

• Upcoming Pakistan Investment Bonds (PIBs), govt. bonds, auction on January 23, 2018 will have strong implications for the local equity and bond markets. To recall, govt. in the last PIB auction dated December 26, 2018, gave cutoff for PIBs after rejecting bids for two months. A small amount was accepted (Rs22.5bn) with cut off for 3, 5 and 10 years at 12.2%, 12.7% and 13.1%, respectively. Moreover, these cut offs are up 472bps, 345bps and 442bps higher over the last auction for 3 (13 Jun auction), 5 (6 Sep auction) and 10 (13 Jun auction) year PIBs, respectively.  
• Further, the PIB cutoffs in December were higher than secondary market rates by 7-44 basis points, which was a surprise for the market and a signal of further monetary tightening.
• We believe that upcoming PIB auction will likely see strong participation specifically from non-banking financial companies like Mutual Funds (including pension funds) and insurance companies. Some banks may also now participate given these high interest rates while most banks’ participation will come post entry into International Monetary Fund (IMF), as per channel checks.
• Moreover, steepening of yield curve indicates that market is expecting  further monetary tightening.
• A significant amount pick up will result in ratification of govt’s debt profile and movement of debt from SBP to banks. The govt. has increasingly resorted to the State Bank of Pakistan (SBP) since the end of last IMF program (in October 2016) where borrowing from SBP now stands at ~Rs7tn, up ~Rs5.5tn since FY16.
• It should be noted that borrowing from central bank and printing of currency is inflationary. Borrowing from banks (through PIBs) will result in lengthening of govt.’s debt profile. A shorter debt maturity profile has higher re-pricing risk.
• To recall, GOP issued a huge Rs2.5tn worth of PIBs in 2014. During this time, the banking sector took significant participation in the auctions where the listed banks cumulatively added Rs1.8tn PIBs to their investment portfolios taking their PIB to Deposit share to ~28% by Dec 2014 from 9% in Dec 2013.
• Assuming a similar scenario, we expect Pakistan listed banks to accumulate PIBs in the coming auctions where we expect PIB to Deposit ratio to increase from 15% in Sep 2018 to 30% in Dec 2019 which translates into Rs2.2tn of additional PIBs. Moreover, approximately Rs720bn worth of PIBs are also maturing in 2019, which would take the total PIB participation of Pakistan listed banks to Rs2.9tn.
• On the back of higher participation in PIBs and other sector dynamics, we expect our banking sector earnings to grow by 19% (excluding outliers) in 2019 based on NIM expansion to 4.2% (from 3.5% in 2018).
• Moreover, higher yields on PIBs will also impact the equity market where we expect a shift of investor preference to fixed income from equity with required rate of return on equities increasing to 19-20%.