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20 December 2023

  • There is a tangible improvement in Pakistan’s macro economy, with stability and policy certainty;
  • BoP is comfortable and the resulting stability of the rupee has anchored market sentiments. SBP is managing its FX reserves with a zero current account policy, which means banks should manage $ inflows and outflows without looking for central bank assistance;
  • The delayed IMF tranche is not a source of concern, and the market expects the tranche and other inflows from the IFIs by mid-January 2024;
  • The accompanying IMF Staff Paper should spell out details of the SBA and the first year of the anticipated 3-year EFF. This should energize the reform agenda well before the elections in February 8th;
  • YoY inflation is falling on the back of regular cuts in retail fuel prices that started in October 2023. The market is convinced that interest rates will be cut in January 2024;
  • The outstanding volume of OMOs has stabilized in the past several months, which could be linked to the ongoing SBA. However, if the IMF wants to see this artificial liquidity reduced as part of the SBA (and subsequent EFF), the interest rate cuts will be smaller than anticipated;
  • The recent correction in the PSX was expected. The hope is that with some stability in the stock market and attractive valuations, foreign portfolio inflows could increase;
  • The outlook for the war in Gaza remains very uncertain. Netanyahu has recently said he is against the 2-state solution, which contradicts the US and EU.  Increasingly, Netanyahu’s government is being criticized by the West for its indiscriminate bombing of Palestinian civilians;
  • The real issue in Pakistan is the growing political uncertainty. Although an election date has been set, there is widespread skepticism that the election will be free and fair;
  • With the Establishment calling the shots, there is a strong sense that it will play a pivotal role in creating a coalition government that it controls;
  • However, unlike the Charter of Democracy that allowed for political stability in the 2008 and 2013 elections, conditions are very different now. The consensus is that the coalition government will be weak, which is raising doubts about its ability to champion tough structural reforms;
  • Using AI, Imran Khan is now telling his supporters to participate in the elections. PTI will play the role of the spoiler in the Establishment’s plan for the next government;
  • We end by acknowledging that there are two views on the economy – Half-Full or Half-Empty. Both sides have convincing arguments to support their view.  We tend to align ourselves with the Half-Full school on the assumption that economic reforms take center stage irrespective of politics.  Politicians and people must understand that any interruption in the next EFF (at the negotiation or implementation stage) means instant default, which has a very heavy price.
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21 November 2023

  • The first SBA review is a success, and the 2nd tranche should be released on schedule. The caretaker setup should be given credit for steadying the economy;
  • There are follow-up issues, but none are deal breakers. Specifically, the external financing gap for FY24 remains, but there should be adjusters in the NIR targets; also, the revenue target (and primary surplus targets) remains hard, which means the likely revenue shortfall will be met via backup measures (windfall tax on banks, real estate taxes/valuations);
  • Formal steps to expand the tax base and action on SOEs will be left for the next government. The caretakers have provided a plan, but the next government will have to deliver with action;
  • The external sector is remarkably stable. FX reserves have held up, and SBP has managed the rupee to settle anxieties.  Pakistan should experience another boost to its reserves with the release of the tranche (and other IFI money) and manage a slow fall in liquid reserves;
  • Interest rate expectations have changed, and the market now expects a cut in early 2024 – this is supported by the fall in YoY inflation;
  • A stable rupee and the cut in fuel prices have reduced our inflation projections (average inflation in FY24 is predicted at 22.9%, which is just above SBP’s 20-22% range);
  • Demand management via the fall in wealth linked to real estate holdings (the deemed income tax on empty residential/commercial plots), has reduced imports and the demand for consumer durables. This will be especially challenging for the auto sector;
  • $ repatriations have increased in the past several months after a period when SBP effectively disallowed outflows;
  • While an election date of February 8th has been announced, there is not much enthusiasm. There is a clear sense that PML-N is favored by the establishment, which has been flagged by PPP and is being monitored by external stakeholders;
  • The economic improvement could be short-lived if the next government is elected by a low voter turnout. The next government must be strong to push through hard reforms, which depends on its credibility (i.e., popular support);
  • The massacre in Gaza continues as Arab leaders take a back seat. Earlier fears of an East-West divide have not materialized as Biden tries to return to the status quo.  This will not work, as US views are increasingly at odds with what Netanyahu wants.  This issue could still escalate;
  • If Israel’s operations against Palestinian civilians continue unchecked, religious parties in Pakistan may take a hard stance and change the political narrative in the forthcoming election. A strong anti-US reaction will complicate the political outlook.
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20 October 2023 (updated on 27 Oct)

  • Rupee appreciation and cut in fuel prices help sentiments. However, this feels like a comfortable limbo where underlying uncertainties have not been resolved;
  • Lack of news on the SBA from the meetings in Marrakesh was unsettling. However, subsequent data releases show that GoP has managed to meet key performance criteria (primary surplus, FBR revenues, NIR, NDA, GoP guarantees, etc.), which means the forthcoming IMF review mission should be successful;
  • World Bank Group (WBG) warns that GoP’s privatization plans could face litigation for not being competitive and transparent. This undermines the mandate of SIFC;
  • The $ financing gap in FY24 has been acknowledged by both the IMF and MoF. This is strange as the IMF does not support a reform agenda unless the external gap is fully funded.  We expect this issue to be resolved after the review mission;
  • Clampdown on money changers (MCs) reduces capital flight and is reflected in higher remittances in September. It also reduces the kerb rate and brings down the premium;
  • OMO data has been revised, which shows the outstanding volume of OMOs falling in the past two months. This could reflect the positive developments on the revenue side;
  • The inflation outlook has improved in the past month as the rupee gained and fuel prices were cut. Our avg inflation prediction is now 22-23%, which is close to SBP’s estimate;
  • The IMF review mission is expected on 2nd This should be successful, but we sense that preparatory legislation will be required to increase the tax base and to bring the provincial and federal governments on the same page;
  • CAD in September fell to just $ 8 mln, driven by subdued imports and the remittance spike. Pakistan’s BoP remains comfortable unless there is an oil price shock (Gaza);
  • NS returns to Pakistan aided by the state. His political message is outdated, and his alliance with the caretaker setup is obvious.  PPP fears manipulated elections to bring PML-N back into power and stepped up criticism of the caretakers.  It also says that PTI must be allowed to contest.  We see common ground developing between PPP and PTI;
  • The war in Gaza has been raging for the past three weeks, and the impact on Palestinian civilians is heart-wrenching. The West has not pushed for a ceasefire, and Netanyahu has formed a unity government to achieve his goal of exterminating Hamas;
  • Hezbollah has warned that if the ground offensive starts, it may get involved. While the US has taken a clear stance, China/Russia & Saudi/Iran are perhaps planning a united response.  One idea is an oil embargo against Western countries (ala 1973) – OPEC+ is well placed to do this.
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20 September 2023

  • In a surprise move, both the ECP and Caretakers announced they would obey the decision of the Supreme Court (SC) regarding the date of the general elections. The SC has been consistently saying that elections should take place within 90 days, which means elections are likely in November.  This means a change in the game plan by the Caretakers (i.e., establishment);
  • With the slide of the rupee and the sharp increase in sugar prices, the Caretakers moved hard against moneychangers, smugglers (Iranian fuels), hoarders (dollars and sugar), power theft, and unpaid bills. The rupee stabilized, and the PSX has recovered;
  • SBP’s FX reserves continue to fall, but the central bank can manage the pace by controlling the pace at which delayed $ payments are cleared. With a sharp fall in aggregate demand, it appears that Pakistan’s BoP is manageable, as monthly imports should be financed by exports and remittances;
  • Caretakers and the establishment appear to pin their hopes for economic recovery on substantial inflows via SIFC. This may not materialize in the short term as FDI flows are staggered and encumbered and cannot be used to provide relief to the people;
  • With global oil prices rising and zero fiscal space, fuel prices will increase further. Furthermore, the expected gas price shock (with three months of arrear payments and higher tariffs) will further burden the common man;
  • Our average inflation projection for FY24 is 30.4%, with a significant YoY spike in September and October. Our rupee prediction of Rs 336.7/$ by June 2024 is slightly worse than the average projection of a survey of analysts.  Hence, claims that the rupee could fall to Rs 360-400/$ by June are exaggerated.  One must realize that a weak currency has a direct impact on the circular debt, which is now a policy priority;
  • SBP surprises the market by not increasing the benchmark rate. This is despite elevated inflation and a likely spike in the next two months.  This calmed market expectations, and rates may remain stable for a few months;
  • The change in the Chief Justice of Pakistan (CJP) could herald a new beginning for the SC. Justice Isa has called a full bench hearing of the Practices and Procedures Act 2023 and said it will be telecast live on TV.  This unprecedented move could generate public support for the SC and give it the moral authority to make sensitive decisions (e.g., date of elections, IK incarceration and political ban, and heavy-handed security laws).  This could resolve the political confusion that currently exists;
  • The most significant development in the past month is the sudden collapse of disposable income. This has impacted retailers/eateries/service providers very hard and is likely to spill over in terms of job losses.  Managing this cost-of-living crisis has become the government’s top priority, but there is no fiscal space to make life easier;
  • The upside of this economic pain is that public anger against the Discos and the international embarrassment created by PIA, has created a constituency that will push for real reforms in dysfunctional SOEs. This goal has eluded the country because of political and institutional push back against reforms.
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21 August 2023

• Pakistan is facing a constitutional crisis with President Alvi disowning two key legislations (Official Secrets Bill 2023 & Pakistan Army Bill 2023). These laws are instrumental in arresting PTI leaders and the trials against PTI supporters. The Supreme Court (SC) will have to get involved;
• The Caretaker setup is sworn in. The cabinet is mainly professional, with an establishment tilt and some business insiders. The economic team of Shamshad and Waqar Masood is seasoned and pro-IMF;
• The Caretaker’s economic agenda is simple: SBA; SIFC; circular debt; and SOEs. We do not expect much in terms of expanding the tax base (to capture retailers and agri) or restricting spending by the government and the army;
• The ECP has announced that general elections will be delayed by four months to complete the delimitation exercise based on the 2023 census. The general public, political parties, and media outlets are split on the delay, but external stakeholders may prefer elections in 2024;
• We anticipate a positive first meeting between the Caretaker government and the IMF. With the priority attached to SIFC, we think the SBA parameters should change to reflect a better BoP outlook;
• The Caretakers have started their term by sharply increasing fuel prices, power tariffs, and allowing for a weaker rupee. This will unleash another bout of inflation – our projection for avg inflation in FY24 is now 31.8%;
• This, coupled with taxes on real estate holding and transactions, will sharply reduce aggregate demand. Elites are experiencing a negative wealth effect, while the middle class is struggling with the sharp increase in power tariffs and fuel prices;
• The current account deficit (CAD) surprised the market when it posted a deficit of $ 809 mln in July. This can be traced to clearing import and service payments arrears as GoP has committed to removing all restrictions in the SBA. In our view, the trade deficit and service outflows will remain elevated in the next several months;
• Remittances continue to trend down, which can be traced to capital flight. The latter could be due to political uncertainty, repressive legislation, and the liquidation of real estate assets. Pressure on monthly remittances is likely to stay in play during FY24;
• The next few weeks (month) are critical as several issues will play out: (1) How will the Supreme Court respond to the constitutional crisis, and how will the establishment react to this; (2) How will the Caretakers respond to the acute austerity the economy will likely experience? We argue that this episode of slow economic growth could be much worse than previous episodes of austerity; and (3) How will the country respond to the delay in general elections?

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21 July 2023

• Securing a 9-month Standby Arrangement (SBA) at the last minute has completely changed Pakistan’s economic outlook. From certain default, SBP’s FX reserves have jumped to $ 8.7 bln, while the rupee appreciated and PSX booms;
• SS gets credit for his direct intervention to secure the SBA;
• IMF Staff Paper is critical of Dar’s management of the rupee and SBP’s subservience. It says the downside risks associated with the SBA are “exceptionally high,” a clear reference to past slippages and the fact that this is an election year. However, the IMF has warned that Pakistan faces a narrow road to recovery, and if program targets are not met, multilateral/bilateral flows could be delayed, which effectively means sovereign default;
• SBA to focus on the kerb premium, tax on retailers and real estate holding/transactions, power tariff increases, gas supply chain, restructuring SOEs, and releasing quarterly GDP data. The FX reserve buildup in FY24 is limited, which means the external sector will operate on a tight leash. The SBA does not see any structural change in Pakistan’s trade sector, and its medium-term BoP projections are not credible;
• June’s current account balance posts a surplus of $ 334 mln, which brings down the CAD in FY23 to only $ 2.6 bln. This was necessary but also took a significant toll on the economy. Non-oil imports fell by 35%, which has a direct bearing on underlying economic activity. The IMF claims that growth last year was negative 0.5% and downgrades GoP’s growth projection for FY24 from 3.5 to 2.5%;
• The IMF also projects avg inflation in FY24 at 25.9%, which is very close to our projection (26.4%). This means interest rates will remain elevated and may even rise in the months ahead. With the sharp erosion of household wealth (which saves primarily in real estate), we think aggregate demand will fall and contain import demand. The IMF’s CAD projection of $ 6.4 bln I FY24 is reasonable even if import restrictions are lifted;
• SS is looking good and is confident about being reelected, but the path for PML-N is unclear. Punjab is the political battleground, with PML-N, IPP, and PTI contesting – the establishment is also rooted in Punjab. This uncertainty will impact the composition of the federal government;
• As part of the systematic effort to weaken PTI, PTI-Parliamentarians has been created by Pervez Khattak in KP. While IK remains tied up in a litany of court cases and is barred from making public statements, we think he will become more vocal as the campaigning starts;
• Most analysts see a weak coalition government in the future. The establishment will be a decisive player, but it must be careful to ensure the forthcoming elections are not perceived as stage-managed.

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20 June 2023

• The EFF has prematurely ended after eight reviews. The PML-N government is desperately trying to revive it, but this is posturing to avert blame;
• The FY24 budget was business-as-usual but should have been very different to secure IMF support. The targets are of academic interest only, as the budget will have to be thoroughly redrafted by the next government when talks with the IMF restart in Nov/Dec 2023;
• The budget claims 3.5% growth, avg inflation at 21%, a fiscal deficit at 7.2% of GDP, an inflation-driven increase in FBR revenues (tax-to-GDP remains below 9%), and no information about the BoP in FY24;
• Dar has shown the $ 3 bln from Saudi and the UAE that should have been released this fiscal year (if the SLA was signed), as inflows in FY24. This means there are no fresh $ inflows in 1H-FY24. With $ 4 bln debt repayments in this period that cannot be rolled over, Bloomberg thinks default is now highly likely;
• The CA surplus in May ($ 255 mln) was a surprise and the full-year CAD could be below $ 3 bln. This has helped shore up SBP’s FX reserves, but with no fresh $s expected in the months ahead, Pakistan’s BoP will have to be even more carefully managed in the next few months;
• We have formulated our inflation projections for FY24, which predict that avg inflation would be closer to 29% on the basis of a heavily depreciated rupee;
• With the EFF off, SBP will continue to inject artificial liquidity into the system (via OMOs), keep the rupee stable, and not increase interest rates. The new government will have to course correct, which means 2024 will be painful;
• PTI has been neutralized and a new political party has been created (IPP). Cracks have developed in the PDM coalition as PPP gears up for the forthcoming elections. PML-N faces the greatest challenges: a failed economy; IPP that is Punjab based; PPP targeting South Punjab; and an establishment that cannot be happy with PML-N’s economic management. While PTI is no longer a political force, one should not write off IK and his latent popularity;
• Political dynamics suggest that a coalition government will take charge after the elections;
• With the EFF ended, PML-N will only be motivated by the forthcoming elections. The blame game will escalate as the economy lists aimlessly;
• Economic stability will only come from an empowered caretaker setup, with a mandate for tough austerity measures.

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19 May 2023

• It’s all about politics, clashing institutions, and violence in May. The army is front and center, and PTI is on the receiving end;
• May 9th is a significant marker in the country, perhaps one of a handful of events since the loss of East Pakistan in March 1971;
• IK is arrested in the morning, which triggers demonstrations in many cities. Most are disruptive (blocking roads, expressing anger, chanting), but some turn violent. Jinnah House is vandalized and burnt down, and GHQ’s main gate in Rawalpindi is breached. The army high command condemns these attacks and begins a media campaign about its role in protecting the country and its sacrifices. The PDM government extends full support to the armed forces;
• The rupee hits 295/$ on May 11th but comes back down to 285/$ the next day. PML-N leaders use the currency collapse as further proof of the destabilizing influence of IK and the PTI;
• IK is released on May 12th by the Supreme Court, spearheaded by the CJP. This blindsides the government, and parliament decides to file a reference against the CJP. PML-N/JUI demonstrates outside the SC, even with Section 144 in force – PPP is conspicuously absent. The gathering is not resisted by the Punjab police, and this double standard gains media attention;
• IK returns to Zaman Park and releases a video message where he continues to target the previous and current COAS;
• The army decides to try the rioters of May 9th under the Army Act, and SS promises to arrest all perpetrators within 72 hours. The National Security Council approves the use of the Army Act, but independent analysts raise questions about this decision, with some saying the Supreme Court may intervene to rescind this decision;
• Relations with the IMF continue to sour. The IMF is still waiting for commitments of $ 6 bln from bilateral sources, as Pakistan has only secured $ 3 bln so far. Dar has said Pakistan will not default even if IMF assistance is not forthcoming. The 9th review has stalled;
• $ 3.7 bln debt repayments are due in May and June, with most payments in June. With the ongoing crisis, a staff-level agreement is unlikely to be offered, which means repayments in June are in doubt;
• The April CA surplus disappoints at $ 18 mln, especially after the $ 750 mln surplus posted in March;
• Inflation continues to break records, with April’s headline inflation at 36.4% and food inflation at 48.1%. Average inflation for FY23 is expected at just shy of 30%, with food inflation just below 40%. This is uncharted waters, which could have political repercussions;
• We end by arguing that both politics and the economy are facing a similar challenge: there is growing pressure to change the system, but the incumbents are fighting hard to resist it.

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20 April 2023

• GoP has delivered on all prior actions, but the IMF still wants written commitments from bilateral friends to commit $ 6 bln before the SLA is offered;
• This means a wait for another month before Pakistan sees lumpy $ inflows;
• Current Account posted a surplus of $ 654 mln in March. The 9-month CAD is only $ 3.4 bln, which has allowed SBP to keep the rupee and FX reserves stable during the last six weeks – the pressure is off for now;
• Inflation hit a record 35.4% in March, and with fuel prices still increasing, we expect inflation to remain elevated well into FY24. The economic pain on the poor and lower middle class is unprecedented, and the government is not managing this as the emergency it has become;
• SBP hikes interest rates by a further 100 bps, with expectations that an additional 200 bps increase is likely. This will squeeze government spending and could result in delayed payments, including government salaries, in the coming three months;
• The political crisis has become a constitutional crisis. All parties (legislature, judiciary, executive, opposition, and army) share the blame for this state of affairs. The petty back-and-forth between the legislature and the judiciary cannot be resolved without mediation;
• After its verdict on the 14 May elections in Punjab, the Supreme Court is directly instructing state institutions like MoF, SBP, and ECP to follow through and report progress;
• Zardari’s suggestion for unconditional talks between PTI and PML-N may be on behalf of external stakeholders who want to avoid a messy default;
• We suggest a possible timeline: talks after Eid; a joint statement that it is wrong to politicize state institutions; judiciary also backs off; SLA is signed; a suitable Budget is announced (without any political handouts); PDM announces that it will hand over charge to caretaker setup in early July; combined $ inflows from IFIs and bilaterals shore up SBP’s FX reserves; this is gradually drawn-down by caretakers till elections in October; IMF starts negotiating the next EFF with the newly elected government;
• From the recent behavior of the IMF, we sense that Pakistan may become a pawn in the tussle between the US and China in how to manage third-world debt. The US wants China to take a hit from overlending in Asia and Africa, but China wants the burden to be shared with multilaterals;
• GoP has been silent on the matter, accepting the IMF’s viewpoint. To avoid a state of limbo, policymakers need to initiate bilateral talks with China, Saudi, UAE, & Qatar, to see if Pakistan’s debt can be swapped for assets. Only by easing the stream of future $ repayments will Pakistan be able to embark on credible economic reforms.

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21 March 2023

• Relations with the IMF are tense. The authorities are blaming the IMF for delaying the staff-level agreement (SLA), while the Fund is unhappy with the direct credit line for GoP and is weary of GoP’s desire to cross-subsidize fuel to provide relief for less affluent households;
• The IMF also has reservations about GoP’s lower external financing requirement, which means a smaller CAD (by continuing to delay payments) and a slower build-up in SBP’s FX reserves. Although a compromise has been reached, we think this makes EFF Part 2 inevitable;
• The IMF is also demanding written guarantees from Pakistan’s friends that they will release fresh funding when the EFF is approved. The FY24 budget will be an important marker that the IMF will closely watch. With mounting economic pain and pending general and provincial elections, PML-N will want to include some handouts to regain political capital;
• Headline and food inflation have hit record levels, and there is little relief in sight. For February, YoY inflation was 31.5%, while food inflation exceeded 45%. Public anger is mounting;
• The CAD for February was only $ 74 mln, and the falling trend has been in play since July 2022. But this improvement will not help sentiments as it reflects the significant squeeze on the real economy;
• SBP surprised the market by hiking interest rates by 300 bps on 3rd March. This will not reduce inflation, but it will squeeze government spending when the elevated borrowing rates are paid out in three months;
• Pakistan’s FX repayment position is getting dire. As of end-January 2023, repayments in the coming year are $ 23.6 bln while SBP’s FX reserves were only $ 3.1 bln. Pakistan needs to restructure its external debt;
• Open market operations (OMOs) have also reached record levels. As of end-February 2023, SBP had injected Rs 6.3 trn into the money market. Since this liquidity can also be used for imports, the IMF will likely impose containment measures. This means interest rates are likely to increase further;
• Domestic politics continues to dominate the airwaves. There is much talk about arresting and disqualifying IK, but we argue this will do little to change PTI’s political trajectory;
• The more relevant question is whether elections (provincial and general) will be postponed. We argue that two groups have been formed: those who want elections as per the Constitution (Supreme Court, PTI, civil society, mainstream media, and external stakeholders); and those who want to postpone elections (Maryan Nawaz & the Supremo, ECP, the caretaker governments in Punjab and KP, the army and its agencies);
• We think the preferred path is to stick to the Constitution and hold elections.

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