In its first full year of rule, PTI government lead by Imran Khan introduced a number of regulatory actions in CY19, mostly to comply with the conditions imposed by International Monetary Fund (IMF) to remove macro imbalances and structural issues in the energy chain. Major regulatory actions include: 1) adoption of new flexible market determined exchange rate regime as against managed float previously, 2) withdrawal of tax exemptions to various sectors to improve tax collection, 3) utility rate adjustments both in electricity and gas sectors, 4) injection of Rs200 billion in the energy chain to improve liquidity situation and 5) upward revision in the margins of oil marketing companies (OMCs). Regulatory action to be taken during CY20 will largely be directed at implementation of ongoing structural reforms under the IMF program. However, with the bulk of regulatory adjustments behind us and improved macro situation allowing authorities to shift policy focus from stabilization to growth, the fallout from the regulatory action will be relatively mild as compared to CY19.
Banks
Retrospective application of super tax on CY17 earnings (consequent increased effective tax rate for the sector to 42-45% for CY19), introduction of Treasury Single Account (TSA), delay in IFRS-9 implementation and the government ceasing budgetary borrowing from Central Bank and resultantly shifting dependence on Commercial Banks (particularly at a time of lower financing demand) were the major regulatory changes impacting the sector. The introduction of TSA, still in preliminary stages and expected to be implemented phase-wise as per understanding, would result in Government deposits being transferred to Central Bank (Government deposits constitute nearly 15% of total industry deposits). However, it had a negative impact on the stock performance of banks in which government still own a significant stake. IFRS-9 is expected to be implemented from CY21 onwards with initial estimates suggesting impacts ranging from rupees one billion to Rs5 billion.
Power
The regulatory actions in Power sector were in line with the IMF directions. The GoP injected Rs200 billion into the energy chain in March 2019 to bring down the overall stock of circular debt, touching Rs800 billion in January 2019). Bulk of payments was directed to E&Ps and OMCs financed by Energy Sukuk I. This was followed by an announcement of another Rs200-300 billion of cash injection by June 2019. However, IMF’s restriction to keep GoP sovereign guarantees at 2% of GDP in any fiscal year caused a delay in its materialization. The IMF later relaxed this restriction in October 2019, post which Energy Sukuk-II issuing process again picked up some pace. Meanwhile, the government agreement with the International Monetary Fund (IMF) stipulates that electricity tariff be adjusted each quarter and the inefficiencies and other expenditures be passed onto the consumers. As a result ECC approved Rs0.53/KWh and Rs0.17/KWh increase in electricity tariffs in September 2019 and December 2019, respectively. GoP and IPPs reached an agreement to avoid prolonged litigation on local and international forums, where IPPs agreed to withdraw legal charges. The agreement also entails clearance of 50% of all the overdue invoices of the signatory IPPs (which enter into the settlement agreement with GoP) within three months of the execution of the settlement agreement.
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Fertilizer
The regulatory environment remained unfavorable for the Fertilizer sector during CY19. the Government of Pakistan (GoP) ensured subsidized LNG supply to non-operational fertilizer plants (capacity: 900,000 tons or 15% of total capacity) till November 2019. Consequently, the overall industry-wide utilization levels increased to 97% for 10MCY19, from 88% for CY18. LNG based operations and a sudden dip in urea offtake in 4QCY19 resulted in ending inventory to spike to 886,000 tons in October 2019, as against 212,000 tons for October 2018. However, these implications have risen in 2HCY19. Meanwhile, the Fertilizer players were in a comfortable position in the earlier half of CY19 as they passed on the impact of gas price hikes and inflationary pressures to the end consumers. With fiscal constraints, IMF ruling out direct subsidies and little to no room to maneuver sales tax (uniform 2%), a presidential ordinance in September 2019 entailed 50% lower prospective Gas Infrastructure Development Cess (GIDC) rates. The Fertilizer players on the other hand ensured GoP to reduce urea price by Rs200/bag, passing on the benefit of lower GIDC to the farmer community. The presidential ordinance, however, was later withdrawn due to pressure from the opposition parties. However, Prime Minister requested the Attorney General of the Supreme Court to hear the GIDC case on priority basis and resolve it in a transparent manner.
Cement
Cement players had an eventful year where regulatory changes mostly contributed to the agony of local players. Already marred by excess capacity posing significant pressure on prices (local prices declined by Rs140/bag during July-September 2019), increase in FED by Rs25/bag to Rs100/bag and implementation of axle load limits increasing the transport costs by more than 50% resulted in margins declining to 5% in 1QFY20 as against 24% in 1QFY19. Select players suffered additional injury from increasing gas prices (increased by 31%) as cost of captive generation increased, while reduction in tax credit on BMR and expansion being decreased to 5% with applicable limit reduced to June 2019 from June 2021 impacted CHCC and MLCF as both players commenced production from new plants in FY19. The same proved to be a dampener for players with expected commencement of expansions in FY21 (LUCK, KOHC and PIOC).