Escalation of Middle East conflict may pose new macro concerns for Pakistan
Published on: April 15, 2024.
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Iran’s recent drone and missile attacks on Israel have raised concerns about a potential wider conflict in the Middle East. While Israel was able to intercept most of the attacks, further exchanges between the two countries could disrupt shipping routes in the region and lead to higher global freight and commodity prices.
The escalation of the conflict may also impact the Pakistani market, which has seen a rally this year. It could test expectations of monetary easing by April/June 2024 and Pakistan’s negotiations with the IMF for another program. However, the market could find solace in the possibility of bilateral assistance and investments from Saudi Arabia, as well as the receipt of the final tranche of the SBA program by the end of April. It is recommended to focus on large caps with high dividend yields, such as UBL, HBL, OGDC, POL, FFC, HUBC, SYS, LUCK, INDU, and ILP.
Even if the conflict de-escalates, there are still concerns about the disruption of shipping routes, similar to what happened in the Red Sea. This could lead to a surge in global oil prices towards $100/bbl and higher global shipping costs due to elevated insurance premiums. Additionally, global food prices may rise, especially for exports from South Asia, such as rice from India and Pakistan.
The escalation of the conflict could also have negative implications for Pakistan’s current account balance and inflation. A 10% rise in global prices of crude oil, chemicals, and food commodities could expand the trade and current account deficit by $200-300 million per month. Furthermore, exports and remittances from Pakistan may shrink due to shipping disruptions and economic concerns in the GCC. This could potentially lead to a reversal in the PKR-USD exchange rate, which has been stable at around 280 since the beginning of the year.
Regarding inflation, there are two scenarios to consider. In Scenario A, with a PKR-USD exchange rate of 295-300 by the end of December 2024, the average CPI for May-Dec 2024 is estimated to be 16%. In Scenario B, if commodity prices rise by 10% and the PKR-USD exchange rate stands at around 315 by the end of 2024, the average CPI for the same period rises to 17%. In both cases, real interest rates remain positive on a forward 12-month basis. However, in Scenario B, the State Bank of Pakistan (SBP) is likely to delay the start of monetary easing until the second half of 2024.
Given the elevated geopolitical risks and potential inflation rebound in Pakistan, it is advisable to focus on large cap sectors like banks, energy, and fertilizers, while being cautious with cyclical sectors like cement, steel, pharma, and autos. Top picks include UBL, HBL, OGDC, POL, FFC, HUBC, SYS, LUCK, INDU, and ILP.
Source: [Trade Chronicle](https://tradechronicle.com)
