KSE100 vs Pakistan Forex Reserves

After much uncertainty, the government of Pakistan has signed a stand-by arrangement (SBA) with the IMF. Under the SBA agreement, the IMF will disburse $3 billion through three tranches. The first tranche is expected to be worth $1.2 billion and is likely to be released around mid-July. The programme will last around six to nine months and will get Pakistan through till a new government is elected.

The SBA agreement was greeted with plenty of fanfare from analysts. The consensus is that the agreement will bring short-term relief and eliminate the possibility of a sovereign default in 2023. Many commentators are also expecting large improvements in Pakistan’s foreign exchange reserves. This is likely to be the case as an IMF agreement will unlock multilateral and bilateral financing.

The markets have reacted jubilantly so far. MSCI’s Pakistan ETF was up 5.5% on 1st July while Pakistan’s dollar bonds have rallied up to 30%; the same dollar bonds are up more than 100% since March 2023. Meanwhile, the dollar was trading at PKR 280 on 1st July, albeit at limited currency exchangers found at airports. For reference, the dollar was trading at PKR 286 on 28th June. The rupee is expected to further rally to 270 against the dollar, although how long it remains at that level is anyone’s guess.

But what about the Pakistani stock market? Well, the stock market will have its first trading day after the agreement on 3rd July. However, a large rally is expected as the market will price in the alleviation of default risk. 

Possible beneficiaries would be sectors which would see improved pricing and cash flows due to the SBA agreement. This would include the power and exploration & production sectors as IMF is likely to push the government to increase gas and electricity tariffs. The banking sector is another one which will likely see a strong rally. Bank stocks had been sliding down over the past few months on the back of heightened default risk and as a consequence, a debt restructuring possibility. Thus, the banking sector will see upward revaluation.

The key question is: will the rally be sustained over a longer period? Many commentators have said it might as Pakistan’s forex position will improve leading to a permanent revaluation of the ‘cheapest stock market in the world’ (as per Bloomberg). But what’s the relationship between Pakistan’s forex reserves and KSE100?

The above graphs show the relationship between the KSE100 index and Pakistan’s forex reserves. In the first graph, KSE100 index is compared to Pakistan’s total reserves (includes forex with SBP+banks and gold reserves) while the second graph compares the index to just the SBP reserves.

Both graphs are seemingly identical and show that the stock market is largely detached from Pakistan’s forex conditions. From the 2000s to mid-2010s, the index rallied all while Pakistan forex reserves were highly volatile. 

This observation is confirmed by the fact that the correlation of the index with Pakistan’s total forex reserves is -0.05. Meanwhile, the correlation of the index with SBP forex reserves is -0.06. Resultantly, there is no relationship between the index and Pakistan’s foreign exchange reserves. 

So, if the stock market does see a sustained rally in the long run, it’s unlikely to be a result of increased foreign exchange reserves.