TWIN DEFICITS WIDENING FY18 FEDERAL BUDGET

TWIN DEFICITS WIDENING FY18 FEDERAL BUDGET 28 th May 2017 Research Entity Notification No.: REP-116 See last page for analyst certification and other important disclosures

FY18 Federal Budget Table of Contents Investment Summary Macroeconomic Analysis Special Focus - Agriculture Stock Market Sectors Autos Banking Consumer & Pharmaceuticals Cements Fertilizers Information Technology Insurance Oil & Gas Exploration & Production Oil Refining & Marketing Power Steel Telecommunication Textile Salient Features 03 04 12 14 16 18 19 20 21 22 23 24 25 26 27 28 29 30 31

1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 Investment Summary Twin deficits widening The major highlight of FY18 federal budget is 37% jump in PSDP allocation to PKR 2.1 tn, which attempts to boost GDP growth rate by stimulating aggregate demand besides serving the purpose of attaining popularity closer to general elections. External account is already bearing the pain of rising consumer as well as industrial demand, visible in the form of 12% growth (USD 2.5 bn) in non-oil non-machinery imports in 10MFY17, amid depressing exports. We believe further impetus to aggregate demand owing to expansionary fiscal policy will add pressures to external account and exchange rate. An overvalued currency amid record low interest rates, elevated public spending, and limited domestic resources has surged the demand for imports, causing unusual widening of trade deficit. Non-oil non-machinery trade deficit swelled 86% Y/Y to USD 5.9 bn (2.3% of GDP) in 10MFY17. Widening current account deficits amid shrinking FX reserves are likely to bring PKR under pressure. A sharp currency devaluation at any point in time shall have serious implications for economic growth, though near term outlook remains promising thanks to accelerating investment cycle. Short term impact of the budget can broadly be assessed as slightly negative for the stock market owing to increased taxation on capital gains and dividends with roughly neutral to positive implications for major sectors. Nevertheless, macroeconomic deterioration owing to widening twin deficits can have serious adverse ramifications. Current Account Balance 1.0 0.4% 0.5 0.2% - 0.0% (0.5) -0.2% (1.0) -0.4% (1.5) -0.6% (2.0) (2.5) -0.8% (3.0) -1.0% Current Account Balance (USD BN) Current Account Balance (% GDP) Source: SBP, Zakheera Budget Balance - 0.0% (100) -0.5% (200) -1.0% (300) (400) -1.5% (500) -2.0% (600) (700) -2.5% All in all, our investment strategy is focused around PKR depreciation with allocations to sectors with USD asset exposures. Budget Balance (PKR BN) Source: MoF, Zakheera Budget Balance (% GDP) 3

MACROECONOMIC ANALYSIS

Macroeconomic Targets Multiple obstacles along the way While the government likes to take pride in curtailing fiscal deficit from 8.2% in FY13 to 4.2% in FY17, we recall that the PML-N government had settled PKR 480 bn circular debt in Jun-2013 thereby bloating FY13 budget deficit base by nearly 2.1% of GDP. Moreover, 4.2% deficit for FY17 looks highly ambitious since 9MFY17 deficit has already reached 3.7% of GDP and 4 th quarter tends to observe seasonally higher deficit. The incumbent government has clearly struggled with generating tax revenues as evident from imposition of new / higher taxation measures over the past 4 years. Reduction in corporate tax from 35% to 30% for non-banking companies has been complemented by imposition of super tax at the rate of 3% for 3 rd year in a row, effectively implying a decrease of 2% only, whereas banking sector pays 39% effective taxation. Broadly, budget appears to be focusing more on spending owing to looming general elections as visible in 37% growth in budgeted PSDP allocation, which coupled with low interest rates amid expanding investment cycle is likely to provide further impetus to aggregate demand. As mentioned earlier, the external account is already bearing the brunt of rising domestic demand in the form of 12% Y/Y higher (USD 2.5 bn) non-oil non-machinery imports. Further stimulus to aggregate demand may have serious repercussions for the external account as well as overvalued exchange rate. Though near term economic growth is likely to remain elevated thanks to large scale investments, a sharp currency devaluation at any point in time may hurt broader economic activity and pull down GDP growth as well. Revised Target Target Target Targets FY17 FY18 FY19 FY20 Real GDP Growth 5.3% 6.0% 6.5% 7.0% Inflation 4.5% 6.0% 6.0% 6.0% Total Revenue 16.2% 17.2% 17.3% 17.5% Tax Revenue 13.1% 13.7% 14.2% 14.6% Non Tax Revenue 3.1% 3.5% 3.2% 2.9% Total Expenditure 20.4% 21.3% 21.3% 21.4% Current 15.9% 15.0% 14.6% 14.6% Development 4.5% 6.3% 6.7% 6.8% Fiscal Balance -4.2% -4.1% -4.0% -3.9% Total Public Debt 64.8% 61.4% 57.8% 54.3% GDP (MP) PKR Bn 31,862 35,919 40,876 46,597 Source: MoF 5

Consolidated Fiscal Analysis Gearing up for a larger deficit in FY18 Interestingly, the government has revised up fiscal deficit target for FY17 to 4.2% of GDP from 3.8% previously whereas GDP growth rate has been revised down from 5.7% to 5.3%, implying an upward revision of PKR 62 bn only in absolute terms which seems to be coming almost entirely from PKR 50 bn lower estimated provincial surplus. The estimates appear to be completely negating FBR s lower than targeted tax collection, as a result of which final deficit number is likely to significantly overshoot estimates. FY18 budget visibly chalks out government s plan to ramp up spending prior to general elections. Tax exemptions, large subsidies, ad hoc raises in salaries / pensions, higher minimum wage, and sky high PSDP allocation, all point to the same. Similarly, revenue collection targets look highly ambitious in the absence of substantial new / higher taxation measures. The government has budgeted PKR 347 bn in provincial surplus to keep deficit in check; however, the provinces may also feel tempted to consume all resources at hand closer to elections. Actual provincial surplus stood at PKR 142 bn only in FY16 against a target of PKR 339 bn. Likewise, 9MFY17 surplus stands at mere PKR 138 bn as opposed to a revised target of PKR 290 bn. While POL products earn huge sums for the government, rising international oil prices and/or PKR devaluation may not be passed on to consumers which may dent sales tax collection. Though the governments have cut PSDP allocations in the past to lower deficits, we eye low probability of history repeating itself given ruling government s plans to ramp up spending after 3 years of fiscal austerity under the IMF program. Target Revised Target Fiscal Summary (PKR Bn) FY17 FY17 FY18 Tax Revenue 3,956 3,825 4,330 Non Tax Revenue 959 912 980 Gross Revenue Receipts 4,916 4,737 5,310 Provincial Share 2,136 2,121 2,384 Net Revenue Receipts 2,780 2,616 2,926 Current Expenditure 3,400 3,398 3,477 PSDP Federal 800 715 1,001 Other Dev. Expenditure 157 128 152 Federal Deficit 1,615 1,627 1,827 Provincial Surplus 339 290 347 Consolidated Deficit 1,267 1,337 1,480 Source: MoF 6

Budgeted Revenues Lacking a coherent strategy FBR s tax collection target has been set at PKR 4.0 tn for FY18, depicting an increase of 14% over downward revised FY17 target of PKR 3.5 tn, with approximately 56% of the growth budgeted to be achieved in the form of indirect taxation. Revenues (PKR Bn) Target Revised Target FY17 FY17 FY18 Income tax collection target under direct tax collection has been set at PKR 1.6 tn in FY18, which represents a growth of only 2.5% over last year s budgeted estimate. Interestingly, revised estimate for FY17 stands 11% lower than the initial target. Sales tax collection target of PKR 1.6 tn looks difficult in the wake of a number of exemptions announced in the budget to boost economic growth. While POL products earn huge sums for the government, rising international oil prices and/or PKR devaluation may not be passed on to consumers which may dent sales tax collection. The FY18 budget seems to be lacking a coherent strategy for widening of tax base and relies on increased taxation on non-filers to achieve growth in tax collection. However, non-filers have been passing on the impact of higher taxation in their invoices to consumers, thereby leaving no penalty. While some of the largest sectors of the economy remain exempt from income tax, burdening the existing tax payers with additional taxes has remained the focus over the past few years for attaining targets. In this backdrop, it is crucial to introduce tax reforms with rationalization of taxation across different sectors to allow more inclusive growth. FBR Taxes 3,621 3,521 4,013 Direct Taxes 1,558 1,379 1,595 Income Taxes 1,539 1,364 1,578 Others 19 15 17 Indirect Taxes 2,063 2,142 2,418 Custom Duties 413 491 581 Sales Tax 1,437 1,445 1,605 Federal Excise Duty 213 206 232 Other Taxes 335 304 317 GIDC 145 80 110 GDS 35 65 43 Petroleum Levy 150 155 160 Others 5 4 4 Total Tax Revenue 3,956 3,825 4,330 Source: MoF 7

Budgeted Expenses Hinting underestimation With current expenditures excluding foreign loan repayments projected to decline 3.6% to PKR 3.76 tn in FY18 from revised estimate of PKR 3.90 tn in FY17, we believe the government is acting highly conservative as it projects debt servicing charge to remain flat at PKR 1.36 tn amid bottoming out of domestic interest rates. Expenses (PKR Bn) Target Revised Target FY17 FY17 FY18 The government s borrowing requirements are likely to remain elevated in the backdrop of structurally high federal deficit and massive PKR 1.0 tn PSDP spending. At the same time, interest rates in the global arena are increasing gradually driven by policy shift in US, which may add pressure to external debt servicing expense. Large current account deficits amid dismal foreign direct investments may also push government to borrow externally to keep FX reserves and thus PKR stable. Besides, subsidies target may also prove to be conservative post commissioning of Coal and LNG based power projects, which may jack up power tariffs due to large capacity payments. The government may not pass on the burden of higher electricity tariff to final consumers in the final run up to elections, thereby swelling subsidies. Markup Payment 1,360 1,361 1,363 Domestic Debt 1,247 1,228 1,231 Foreign Debt 113 133 132 Pension 245 245 248 Defense 860 841 920 Grants / Transfers 442 382 430 Subsidies 141 169 139 Civil Government 353 399 377 Total Current Expenditure 3,400 3,398 3,477 Source: MoF 8

FY13 FY14 FY15 FY16 FY17 FY18 Subsidies Poor history of achieving subsidy targets Subsidies (PKR Bn) FY13 FY14 FY15 FY16 FY17 FY18 Revised Revised Revised Revised Revised Budgeted Subsidies: Budgeted vs Revised 400 PKR BN 350 WAPDA/PEPCO 265.0 245.1 185.0 117.8 102.6 102.5 300 250 200 KEL 84.3 64.3 36.0 53.4 15.4 15.5 150 100 50 USC 6.0 6.0 10.3 5.0 7.0 4.0 - PASSCO 6.2 6.5 10.9 10.0 18.6 16.5 Source: MoF Budgeted Revised Food & Research - - - 10.0 25.1 0.0 Others 6.0 1.1 1.1 0.3 0.3 0.3 Total Subsidies 367.5 323.0 243.2 196.5 169.0 138.8 Source: MoF 9

FY12 FY13 FY14 FY15 FY16 FY17 FY18B FY12 FY13 FY14 FY15 FY16 FY17 FY18 Public Sector Development Programme Augmenting spending to boost growth FY17 FY17 FY18 PSDP (PKR Bn) Budget Revised Budget Federal Ministries 282 299 378 WAPDA (Power) 130 134 61 National Highway Authority 188 210 320 PM's SDGs 20 43 30 PSDP: Budgeted vs Revised 2,500 PKR BN 2,000 1,500 1,000 500 Special Federal Development Programme 28-40 - Energy for All - - 13 Clean Drinking Water for All - - 13 Source: MoF Budgeted Revised ERRA 7 11 8 Special Provision for Competition of CPEC - - 5 Relief and Rehab. Of IDPs 100-45 Security Enhancement - 14 45 PM's Initiatives 20 5 20 GIDC 25 0 25 PSDP: Historical Allocation 2,500 PKR BN 2,000 1,500 1,000 500 Federal PSDP 800 715 1,001 - Provincial PSDP 875 824 1,112 Total PSDP 1,675 1,539 2,113 Source: MoF Source: MoF Federal Provincial 10

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Distribution of resources and liabilities Federal trapped in a structural deficit Federal Shares in Revenues and Expenses 90% 80% Post 7 th NFC award, uneven distribution of resources and liabilities between federal and provincial government has trapped federal government in a structural deficit. 70% 60% 50% The federal government s share averaged 53% of the consolidated revenue during the past 5 years while it bore an average of 70% of the consolidated expenses during the same period. 40% 30% 20% 10% Almost entire amount of the federal revenue is spent on debt servicing and defense related expenditures; as a result of which the federal government has to rely on borrowings to fund other current and development expenditures. 0% Source: MoF Federal Share in Expenses Federal Share in Revenues Federal government s reliance on borrowings from domestic banking system for funding its expenditures is likely to increase as it ramps up spending, e.g. massive PKR 1.0 tn federal PSDP expenditure, closer to elections. Aggressive government borrowing from the banking system should keep money supply growth elevated, in line with past trends. Debt Servicing + Defense Expenditures 120% 100% 80% 60% 40% 20% 0% Debt Servicing (% Federal Revenue) Source: MoF Defence (% Federal Revenue) 11

AGRICULTURE

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 Agriculture Modernization crucial for survival Continuing with its populist agenda, the government has drawn special attention to the agriculture sector through substantial (43%) increase in agriculture credit disbursement as well as various sales tax exemptions and concessions. The announcements aim to provide economic relief to the farming community. Agriculture Sector 30.0% 25.0% 20.0% 35.0% 30.0% 25.0% The budgetary measures on agriculture also seem to be initiated in context of planned Chinese initiatives under CPEC as revealed by recently published articles in the local press. 15.0% 10.0% 20.0% 15.0% 10.0% Chinese enterprises have long term plans for agriculture sector in Pakistan that run from one end of the supply chain to another. From inputs like seeds and fertilizers, Chinese also plan to operate farms and processing facilities along with the logistics. 5.0% 0.0% 5.0% 0.0% Agriculture %GDP (LHS) Agriculture %Growth (RHS) As a matter of fact, the government has mostly announced subsidies / reduction in taxes and duties to support agricultural sector, which has only led to fiscal slippages in the past. However, it fails to account for poor irrigation systems, low quality seeds, old farming techniques, and lack of innovation in the sector. Source: PBS, Zakheera Hence, we believe it is highly critical to modernize our agriculture sector to compete with the forthcoming new entrants. 13

STOCK MARKET

Stock Market Negative Taxation on capital gains and dividends increased New taxation regime for capital gains tax has been introduced wherein previous time-based capital gains taxation has been replaced with flat taxation. Revised tax rates include 15% for filers and 20% for non-filers. However, CGT exemption will continue for holding period of more than 4 years. WHT rates on dividend income have been revised upwards from 12.5% to 15.0%; however, dividend income from power companies will continue to be taxed at the concessionary rate. Likewise, dividend tax rate on mutual funds has also been increased from 10.0% to 12.5%. Earlier, public companies had to pay a tax rate of 10% on reserves if they failed to payout lower of 40% of after tax profit or 50% of paid up capital. A change to Section 5A abolishes the condition of 50% of paid up capital and now requires public companies to payout at least 40% of after tax profits as dividends or bonus shares to avoid paying tax on reserves. We believe issuances of bonus shares will allow the companies to meet the new requirement as well as preserve liquidity. Public companies do not include scheduled banks, modarabas, and companies with government holding more than 50% shares. 20% tax credit was available for 2 years to companies listing on the PSX. The credit has been extended for 2 more years with 3 rd and 4 th years bearing credits of 10%. WHT of 0.02% on brokers, adjusted previously, has now been made part of the final tax regime. It does not bode well for brokers profitability since the industry operates on thin margins. Capital Gains Tax 2017 Filer Non-Filer < 12 Months 15.0% 18.0% 12-24 Months 12.5% 16.0% 24-48 Months 7.5% 11.0% > 48 Months 0.0% 0.0% Source: MoF Capital Gains Tax 2018 Filer Non-Filer < 12 Months 12-24 Months 24-48 Months > 48 Months 15.0% 0.0% 20.0% 0.0% Source: MoF 15

SECTORS

Summary Sectors Impacts Key Measures Autos WHT on vehicle registration reduced / ST on above 2,500 cc hybrid cars reduced / Agriculture credit increased to PKR 1 tn Banking Consumers & Pharmaceuticals Cement Fertilizers Exemption of withholding tax on branchless banking / Tax neutrality on Islamic financing vis-à-vis conventional banking / enhancement in agriculture credit disbursement to PKR 1 tn Decrease in WHT on sales of FMCGs distributors/ CD on baby diapers raw materials and non-woven fabric (Pharma) reduced / CD increased on aluminium beverage cans / Sales promotion & advertisement expense limit relaxed for Pharma FED increased to PKR 1.25 per kg / PSDP increased by 37% to PKR 2.1 tn / house building finance risk sharing guarantee scheme introduced Adjustable tax on imported DAP classified as final tax / ST on natural gas and phosphoric acid reduced to 10% and 5% / ST maintained but cash subsidy reduced on Urea / Flat ST to replace subsidy on ammonia fertilizers and CAN Information Technology 3 years tax break for new companies / Exemption from levy of minimum tax as well as WHT Insurance Minimum insurance premium threshold for collection of advance tax increased / Lower limit of health insurance premium for claiming tax credit increased Oil & Gas Exploration & Production Sui field to be taxed as per 5th Schedule of the Income Tax Ordinance / Limited application of Super Tax Oil Refining & Marketing Power Steel 2% extra tax on lubricating oil withdrawn / Inapplicability of increase in minimum turnover taxation / PKR 320 bn (+52%) allocated to National Highway Authority PKR 401 bn earmarked for development of power projects / Power subsidy maintained at PKR 118 bn / CD on imported coal reduced to 3% for IPPs / ST exempted on renewable sources of energy Sales tax on steel sector increased from PKR 9.0/KWH to PKR 10.5/KWH / PSDP allocation increased to PKR 2.1 tn, up 37% from last year s revised estimate Telecommunication FED on telecom services reduced / WHT on mobile phone subscribers decreased / Import duty cut on telecom equipment Textile Continuation of PM s exports package / Continuation of zero rating regime / ST increased on retail sales of export oriented sectors / ST imposed on import of commercial fabric instead of zero rating status 17

Autos Providing relief to the consumers Reduction in WHT on registration of motor vehicles With no impact on ex-factory prices, reduction in WHT will lower the cost of purchase for final consumers. 25% reduction in sales tax rates for Hybrid cars with engines above 2,500 cc This is broadly a non event for local suppliers due to low penetration of Hybrid cars in the market. Agriculture credit disbursement increased to PKR 1,001 bn from PKR 700 bn The credit to small farmers shall be provided at a lower rate of 9.9% (14%-15% previously), which should elevate the demand for tractors. 18

Banking No surprise Exemption of withholding tax on branchless banking Slightly Measure aimed at increasing branchless banking traffic. The exemption may help bring back some of the lost deposits of the banking system. Tax neutrality on Islamic financing vis-à-vis conventional banking Slightly Allowance of depreciation claims on assets jointly owned by a tax payer and Islamic bank, according to Musharika. Enhancement in agriculture credit to PKR 1 tn Agriculture credit is expected to be enhanced by 43% to PKR 1 tn. More than 2 mn loans are projected to be provided by NBP, ZTBL and other banks. 19

Consumer / Pharmaceutical Negligible relief measures Sales promotion & advertisement expense limit increased to 10% from 5% of turnover Increase in promotion & advertisement expense limit will help the manufacturers better penetrate the market and create awareness amongst the less educated local consumers. Custom duty on fabric (non-woven) for pharmaceutical industry reduced to 5% from 16% It will reduce input costs for the industry but non-woven fabric is used in packaging of limited pharmaceutical products. WHT on sale / supply by distributors of FMCGs reduced to 2.0% and 2.5% for companies and non companies It will bode well for the distributors profitability with no impact on exfactory prices. Custom duty on baby diapers raw materials reduced to 16% and 11% from 20% and 16% Lower raw material costs will help local industry compete with the imports of established brands which dominate local market at present. Custom duty increased on aluminium beverage cans to 20% from 11% Negative Increase in CD will increase packaging costs for canned beverages. 20

Cement Higher PSDP allocation to escalate demand PSDP allocation increased to PKR 2.1 tn, up 37% from last year s revised estimate. Major highlight of the development spending remains infrastructure development, which coupled with sky high private construction and CPEC related investments should keep demand for cement elevated. FED increased to PKR 1.25/kg from PKR 1.00/kg Negative Approximately PKR 15/bag price increase required to pass on the adverse impact to final consumers. We believe it can be passed on in the South; however, rising competition may make it difficult for the Northern manufacturers to raise final prices. Risk sharing guarantee scheme - house building finance The government has decided to provide 40% credit guarantee for house building of up to PKR 1 mn to support construction activity in the low income segment. 21

Fertilizer Lower GST rates to improve liquidity GST maintained but cash subsidy reduced on Urea Slightly Negative While the government has maintained 5% GST on Urea, it has reduced the amount of cash subsidy from PKR 17.6 bn to PKR 11.6 bn which translates into a price differential of approx. PKR 50/bag. Flat GST to replace subsidy on ammonia fertilizers and CAN The change in methodology is expected to improve liquidity and ease working capital requirements of the manufacturers thanks to resolution of issues pertaining to delays in subsidy disbursement. GST on natural gas / phosphoric acid reduced to 10% / 5% from 17% It bodes well for the liquidity of the producers in the form of lower amounts of stuck up sales tax refunds. Adjustable tax on imported DAP classified as final tax Slightly Negative EFERT and FFC may be negatively impacted by the new regime since final tax will no longer be available for adjustment against input tax. ST exempted on imported seeds Potentially beneficial for EFERT and FATIMA, which are planning to venture into supply of imported seeds. 22

Information Technology Grabbing some incentives finally 3 years tax break provided to new startups IT based businesses are already gaining attention in the country, however on a small scale. Tax breaks may attract large scale investments as well, such as Ali Baba. Sales tax on export of IT services exempted Sales tax exemption should make export of IT services cheaper and competitive, besides easing liquidity constraints. IT Software Park in Islamabad The government has decided to set up an IT software park in Islamabad with the help of Korean Government at a cost of PKR 6 bn. 23

Insurance Limits modified Minimum insurance premium threshold for collection of advance tax increased Increase in threshold for collection of advance tax from non-filers from PKR 200k to PKR 300k shall lower the cost of insurance for lower / middle income segment and bolster sales volumes for the companies. Lower limit of health insurance premium for claiming tax credit increased Negative Increase in limit from PKR 100k to PKR 150k lowers the attraction of smaller insurance policies and may discourage volumes. 24

Oil & Gas Exploration & Production Non-event for the sector Sui field to be taxed as per 5 th Schedule of the Income Tax Ordinance While Sui field was taxed under a separate agreement, the new rule brings it under the umbrella of 5 th Schedule of the Income Tax Ordinance owing to its conversion to 2012 Petroleum Policy. Though new regime is likely to attract higher taxation, increase in revenues should more than offset the adverse impact. Limited application of Super Tax Slightly Negative Oil & gas fields operating under PCAs are not subject to super taxation; however, old fields operating under agreements shall attract the levy. Nonetheless, entire other income shall be subject to 3% taxation. 25

Oil Refining & Marketing Increased spending should lift demand 2% extra tax on lubricating oil withdrawn Slightly It will be passed on to final consumers. We believe the reduction is very small to trigger any sharp spike in volumes. Inapplicability of increase in minimum turnover taxation Oil refineries and marketing companies shall continue to be subject to lower minimum turnover taxation at the rate of 0.5%. PKR 320 bn allocated to National Highway Authority, up 52% from revised FY17 estimate Demand for Asphalt should see a significant jump, which bodes well for APL s profitability in the form of deregulated margins. However, APL should find competition from PARCO and imports. 26

Power Reliance on subsidies likely to continue PKR 401 bn earmarked for development of power projects The outlay includes PKR 77 bn allocated for two LNG projects, PKR 54 bn for Dasu Dam, and PKR 20 bn for Neelum Jhelum Projects. Power subsidy maintained at PKR 118 bn No concrete steps have been taken to contain the chronic circular debt thus far. Power sector subsidies may overshoot estimates in the wake of large capacity payments of LNG and Coal based power plants. CD on imported coal reduced to 3% for IPPs and a minimum sales tax of PKR 425/MT levied on locally produced coal Both measures are pass through and are unlikely to bear any significant implications for the sector s profitability. ST exempted on renewable sources of energy Sales tax exemption aimed at encouraging consumption of clean energy in the country. Super tax continued at the rate of 3% Negative Super tax expected to dent KAPCO s profitability by PKR 0.35/share. 27

Steel Higher PSDP allocation to boost demand Sales tax on steel sector increased from PKR 9.0/KWH to PKR 10.5/KWH Higher sales tax on power will result in an increase of PKR 1,200-1,400/ton cost of production. We believe local manufactures are in a comfortable position to pass on the impact to final consumers thanks to healthy demand. PSDP allocation increased to PKR 2.1 tn, up 37% from last year s revised estimate Increased government spending on infrastructure shall provide boost to an already robust demand for the local steel sector. Risk sharing guarantee scheme - house building finance GoP has decided to provide 40% credit guarantee for house building of up to PKR 1 mn to support construction activity in the low income segment, resulting in increased flat long steel demand. 28

Telecommunication Reducing taxation on the heavily taxed FED on telecom services reduced to 17% and WHT for mobile phone subscribers reduced to 12.5% This would benefit the consumers in the form of reduced cost and telecom companies in the shape of higher consumer spending. Sales tax rates of PKR 300 and PKR 1,000 per set merged into a single rate of PKR 650 per set With no direct implications for telecom companies, the cumulative impact of the merger of sales tax slabs for consumers as well as the government remains ambiguous. Regulatory duty levied at the rate of 9% on telecom equipment, replacing custom duties of 11% and 16% Being a capital intensive business, the lower duty will reduce the capital costs of equipment as well as preserve cash flows besides encouraging further investments. 29

Textile Incentives carried forward Continuation of zero rating regime Export oriented sectors, i.e. textile, leather, sports goods, surgical goods, and carpets, shall continue to enjoy zero-rating status to reduce their cost of business. ST increased on retail sales of export oriented sectors We believe increase in retail sales tax from 5% to 6% shall be passed on to final consumers with no implications for profitability. ST imposed on import of commercial fabric instead of zero rating status Slightly Negative 6% tax to create sales tax refunds issues with the taxation authorities. Other Qualitative Measures Introduction of hedge trading system for cotton, brand development expenditure, guaranteed supply of electricity and natural gas, and establishment of an online portal to improve B2B and B2C trading. Other Quantitative Measures ERF / LTFF rates maintained at 3.0% / 5.0%, duty free import of textile machinery, and continuation of exports package. 30

SALIENT FEATURES

Key Taxation Measures Agriculture GST on DAP reduced to PKR 100/bag from PKR 400/bag, replacing subsidy on DAP. However, the rate on urea shall remain unchanged. Manufacturing Federal Excise Duty on cement enhanced from PKR 1.00 per kg to PKR 1.25 per kg. GST on steel sector increased from PKR 9.0/KWH to PKR 10.5/KWH. Sales tax on retail sales of five export oriented sectors increased from 5% to 6%. Sales tax increased on commercial import of fabrics from 0% to 6%. Services Sector Capital Gain Tax on securities with a holding period below four years fixed at flat rate of 15% for filers and 20% for non-filers. Tax rate on dividend income increased from 12.5% to 15%. Tax rate on dividend income from mutual funds enhanced to 12.5% from 10.0%. Slabs for taxation of interest income have also been revised as follows: PKR 25 mn slab replaced with PKR 5 mn. PKR 25 mn to PKR 50 mn slab replaced with PKR 5 mn to PKR 25 mn. Above PKR 50 mn slab replaced with PKR 25 mn. Corporate tax rate reduced from 31% to 30%. Extension in super tax 4% on income of banking companies 3% on income of other persons Advance adjustable withholding tax of 0.02% on stock exchange brokers shall now be treated as final tax. 32

Key Relaxation Measures Agriculture Sales tax on agricultural diesel engines (from 3 to 36 HP) exempted. Exemption from whole of sales tax on combined harvesters (restricted up to 5 years old). Exemption from sales tax on imported seeds for sowing. Presently, imported oil seeds are subject to 5% sales tax. Manufacturing Withholding tax on registration of Motor Vehicles reduced as follows: Up to 850 cc from PKR 10,000 to PKR 7,500. 851 cc to 1000 cc from PKR 20,000 to PKR 15,000 1001 cc to 1300 cc from PKR 30,000 to PKR 25,000. Custom Duty reduced from 20% to 16% and from 16% to 11% on raw materials for manufacturers of Baby Diapers. Withdrawal of 2% extra tax on lubricating oils Concession in duty / taxes on Hybrid Electric Vehicles above 2500 cc withdrawn. Reduction in sales tax on import and supply of hybrid electric vehicles. Reduction in sales tax at the rate of 50% is available on import of Hybrid Electric Vehicles up to 1800cc and at the rate of 25% on Hybrid Electric Vehicles exceeding 1800cc. Exemption to vehicles for development of Gwadar Port. Services Start ups in IT sector exempted from income tax for first 3 years. Withholding tax for mobile phone subscribers reduced to 12.5% from 14.0%. Custom Duty at 11% and 16% abolished and introduced at a uniform rate of 9% on the telecom equipment. Federal Excise Duty on telecommunication services reduced from 18.5% to 17.0%. Rationalization of sales tax on mobile phones. Sales tax rates of PKR 300 and PKR 1,000 per set merged into PKR 650 per set. 33

Annexures Other Salient Features Salaries and pension of government employees increased by 10%. Minimum wage increased to PKR 15,000 from PKR 14,000. Pakistan development fund reintroduced. PKR 121 bn allocated to Benazir Income Support Programme. PKR 10.4 bn allocated for Chinese security. PKR 38 bn allocated for Clean Water projects. PKR 357 bn allocated for Higher Education Commission. Regulatory Duty levied/increased on non-essential items (mainly steel, iron & auto parts scrap and apparels) by various rates ranging from 5% to 15%. Custom Duty at PKR 250 per set converted into Regulatory Duty at PKR 250 per set on mobile phones. Reduction of Regulatory duty on aluminum waste or scrap from 10% to 5%. Exemption of 3% Custom duty on raw skins & hides. Reduction of Custom Duty on fabric (non-woven) for pharmaceutical industry from 16% to 5%. 5% Regulatory Duty levied on import of synthetic filament yarn (of polyesters). Increase of Custom Duty on aluminum beverage cans from 11% to 20%. Custom Duty reduced on uncoated polyester film and aluminum wire from 20% to 11% for manufacturers of metalized yarn. Concessionary rate of 11% available on Set top boxes, TV broadcast transmitter and Reception apparatus etc. extended for another year. Custom Duty rate on Bituminous coal and other coal equalized at 5%. However, for the Power Projects in IPPs Mode, Custom Duty on import of both types of coal reduced to 3%. Minimum sales tax on locally produced coal is fixed at PKR 425 per metric ton or 17% ad valorem, whichever is higher. Sales promotion expense as a % of turnover for pharmaceuticals has increased to 10% from 5%. Penalties to be imposed on persons manufacturing, possessing, transporting, distributing, storing, selling non duty paid/ counterfeit cigarettes. Withholding tax on distributors of FMCG products reduced to 2.0% & 2.5% from 3.0% & 3.5%. 34

Pakistan Equities Team Syed Hussain Haider, CFA, CIPM Head of Equity Strategy +92-21-3529 2628 hussain.haider@nextcapital.com.pk Zulqarnain Khan Director +92-42-3579 1282 zulqarnain.khan@nextcapital.com.pk Fatiq Bin Khursheed, CFA Head of Research +92-21-3516 9520 fatiq.khursheed@nextcapital.com.pk Saad Iqbal, CFA Head of Equity Trading +92-21-3529 2642 saad.iqbal@nextcapital.com.pk Research Analysts Oil & Gas Sonia Agarwal +92-21-3516 9519 sonia.agarwal @ nextcapital.com.pk Banks & Chemical Aijaz Siddique +92-21-3516 9515 aijaz.siddique@ nextcapital.com.pk Cement & Autos Sohaib Subzwari +92-21-3516 9518 sohaib.subzwari@ nextcapital.com.pk Engineering Arsalan Ahmed +92-21-3516 9519 arsalan.ahmed@ nextcapital.com.pk Fertilizer Rahul Hans +92-21-3516 9518 rahul.hans@ nextcapital.com.pk Database Akasha Bin Saeed +92-21-35169515 akasha.saeed@ nextcapital.com.pk Equity Sales Head Office: 8 th Floor, Horizon Tower, Plot # 2 /6, Block III, Clifton, Karachi, Pakistan UAN: +92-21-111-639-825 Fax: +92-21-35292621 Url: www.nextcapital.com.pk KARACHI: LAHORE: Zubair Ellahi +92-21-3529 2635 zubair.ellahi@ nextcapital.com.pk Muhammad Yaqoob +92-42-3579 1281 muhammad.yaqoob@ nextcapital.com.pk Ahmed Hanif +92-21-3516 9668 ahmed.hanif@ nextcapital.com.pk Asim Aslam +92-42-3579 1284 asim.aslam@ nextcapital.com.pk Muhammad Shakeel +92-21-3529 3637 muhammad.shakeel@ nextcapital.com.pk Saad Rafi +92-21-3516 9512 saad.rafi@ nextcapital.com.pk Abdul Basit +92-21-3516 9517 abdul.basit@ nextcapital.com.pk

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