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Pre-budget FY 11 – tough task ahead

Federal Budget FY11: A binary outcome for KSE?
Pakistan is set to unveil its Federal Budget for FY11 (Jul-Jun) in first week of June. With IMF firm on tax reforms and fiscal pressures mounting, populist moves are likely to be scant, barring a couple of token announcements and focus will be on raising federal tax/GDP ratio from current 9.2%. As a result, we expect Main Street to feel some heat from the tax measures which will also spill over to Wall Street (i.e. KSE). However the make or break for the KSE would be capital gains tax (CGT) on shares trading or otherwise and its modalities.

Investors will potentially look beyond the budget
We do not underplay the importance of the Budget but we believe investors will potentially also look beyond the budget on two counts: 1) Budget should answer pertinent questions regarding ‘what’ govt plans for addressing the fiscal situation. However. ‘how’ it plans to achieve the ‘whats’ will also garner attention due to new measures like VAT, CGT, Single Treasury Account etc on which is there is lack of clarity/ consensus amongst stakeholders. 2) Irrespective of the targets announced there likely will be an implicit reliance on committed sovereign inflows which would dilute the importance of stated targets vis-à-vis outlook for sovereign flows.
Revenue enhancement + balancing austerity & development 
FY11E total budget of PRs3.2tr (Federal PRs2.25tr) will be a challenge as fiscal deficit (FY10: 5.1% of GDP) needs to be lowered to 4.1% in FY11. While we expect a mix of new and old taxes to perk up revenues, balancing austerity and development likely will be a challenge. With current expenditure expected to remain under stress from defense (PRs448bn; 2.6% of GDP) and debt servicing (PRs693bn; 4.0% of GDP) in FY11E, room for development spending depends on success in eliminating subsidies, which we estimate at ~PRs268bn (1.8% of GDP) in FY10 against FY10 budgeted amount of PRs133bn (0.9% of GDP).
Sector developments: Potential budget winners
Constrained fiscal space would naturally limit beneficiaries of the budget but any substantial steps that address intercorporate debt should be taken positively by KSE as it would partially remove the stigma plaguing stocks in the energy chain.
Sectors that could feel the heat of fiscal reforms
While higher taxes as a whole could hurt demand and investments, inferring from news reports, it appears that banks could feel some pressure due to 250bp higher taxes on banks with spreads over 5% (4% EPS impact) and single treasury account (STA) which could hurt liquidity. Similarly increase in gas prices would inflate costs of industrial production, where impact on margins will depend on pricing power. Petrol products and cements could see higher taxes at retail level which while neutral for margins, could hurt end demand/ future pricing.
KASB Securities and Economics Research
27 May 2010

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