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October 22, 2021

  • The inconclusive IMF-Pakistan talks unhinge the FX and money markets. This is surprising as the sharp increase in fuel prices and reports that Pakistan had agreed to increase power and gas tariffs, were viewed as prior actions that often precede an agreement with the IMF;
  • The rupee continues to weaken (currently trading above 175/$), while the last T-bill auction failed as banks were unwilling to offer money to the government. Market sources claim that the market has already factored in a 100-125 bps increase in the discount rate;
  • No reason has been given for the “inconclusive” negotiations, as key policymakers remain silent about what happened in Washington D.C.;
  • The combined hike in fuel prices and the weakening rupee has stoked inflationary expectations. Our projections show that avg inflation could be as high as 13% in FY22, with food driving the momentum;
  • Realizing the anger this has unleashed, the government is now talking about subsidizing fuel for motorbikes and public transport. This will be very difficult to implement and reflects a degree of desperation in policymaking.  Unfortunately, the surge in food prices will continue;
  • The government has promised a cash subsidy for the poor, but details have not been disclosed;
  • The economic pain has unified the opposition parties, and this momentum will grow as food prices continue to push more people below the poverty line;
  • In our view, the main point of contention with the IMF would be the size of the external deficit in FY22. Even during the finance minister’s visit to D.C., he was quoted as saying that Pakistan would achieve 5% growth this year.  But high growth comes at a price – an elevated import bill and a larger current account deficit (CAD).  At a time of rising commodity prices (esp. food and energy), this is a luxury the IMF would perhaps not allow for.  We argue that Pakistan needs a CAD of $ 13 bln (or more) to achieve high growth;
  • Looking at key imports (oil, food, and auto parts), policy interventions to reign in imports may not succeed, which means the rupee will continue to weaken. September’s CAD of $ 1.1 bln needs to be brought down in the remaining part of FY22;
  • The market is unlikely to settle down without a firm start date for the EFF. This puts a great deal of pressure on policymakers;
  • Aside from the economy, Covid cases are falling and restrictions on public gatherings have eased significantly. The positivity rate is at the lowest level since the pandemic started in early 2020;
  • The lack of sovereign recognition of the Taliban government has pushed Afghanistan to the global backburner. However, the growing humanitarian crisis – which will get worse in the winter – is putting pressure on humanitarian agencies and OECD countries.
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September 20, 2021

  • Global media is turning against Pakistan, as the Taliban government shows little interest in global approval. A month after taking control, no country has recognized the Taliban government.  Furthermore, the last-minute cancelation of the New Zealand cricket tour has further tarnished Pakistan’s image;
  • The size of the current account deficit is becoming alarming, and the rupee has weakened significantly. There is additional pressure from the demand for cash dollars in Peshawar and Quetta because of the looming economic crisis in Afghanistan;
  • August’s CA deficit was $ 1.5 bln. Compared to a full-year deficit of $ 1.8 bln in FY21, the external deficit is now a policy priority.  Imports are driven by food, machinery, autos, chemicals, and textiles.  Policymakers need to reduce imports, even if this means shifting away from growth.  With Afghanistan’s economy unraveling and Pakistan needing to restart the EFF, the focus should be on consolidating the economy;
  • If the global community does not step up with humanitarian assistance for Afghanistan, the burden will fall on Pakistan. This could put pressure on food prices and force the authorities to increase imports.  This could also create a fiscal burden if a large number of Afghan refugees cross the border into Pakistan;
  • With the recent weakness of the rupee and the likely increase in retail fuel prices, we have increased our inflation projections for FY22. From an average inflation prediction of 7.9% this year, we now see inflation at 10.3%.  This, coupled with the need to narrow the external deficit, will compel SBP to raise interest rates;
  • Covid restrictions have eased in Pakistan, as the country crests its 4th Active cases have fallen to below 64,000, which is a very good outcome for the country;
  • As Pakistan struggles with its external sector, navigating geopolitical forces will be more challenging with what appears to be an assertive Biden administration;
  • President Biden has spearheaded the creation of AUKUS (Australia, UK, and the US), which rewards the UK at the expense of the EU (specifically France). This makes NATO irrelevant, and could force the EU to create its own military presence;
  • The Biden administration has effectively set the markers for the new bipolar world. By inviting India and Japan into a new security alliance (the Quad), the US has signaled its intention to contain China’s influence in the South China Sea;
  • As the two superpowers square off, Pakistan (which has shifted its alliance to China and is being blamed by the US for the debacle in Afghanistan) finds itself in uncharted waters. It must stabilize an economy with the additional Afghan burden, in an environment that may not be very sympathetic.
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August 24, 2021

  • The Taliban takeover of Afghanistan dominates our monthly assessment, not just in terms of Pakistan’s foreign policy, but also its national security and the economy. If the battle for the main cities had become a drawn-out urban firefight, and Pakistan was blamed for supporting the Taliban, international sanctions could have easily triggered an economic crisis in Pakistan;
  • The situation in Afghanistan is still very fluid, and while Pakistan has dodged the bullet, it is still vulnerable to a global blame game, terrorist activity in the country, and a large influx of refugees. Having said this, Pakistan has played its cards well;
  • The chaos at Kabul airport will continue till the end of the month, after which the Taliban will announce its government. How the world responds, and whether it will resume aid flows to Afghanistan, is still uncertain;
  • The current account (CA) deficit was $ 773 mln in July. While this is an improvement over the $ 1.6 bln in June, SBP is very concerned and has weakened the rupee to break the import momentum;
  • SBP had projected the CA deficit in FY22 at $ 8.1 bln, but the government thinks it will be $ 13 bln. This confusion means that authorities are unable to release official BoP projections, which makes managing the FX market more challenging;
  • Remittances remain strong (at $ 2.7 bln) but with travel likely to pick up (Saudi has permitted Ummrah travel), pent-up demand to travel could create BoP pressure if remittances fall sharply;
  • Rupee weakness in August shows that SBP is being proactive, but this has also increased our inflation projections for FY22. Compared to the government’s target of 8.2%, we think average inflation will be 9.4%;
  • With elevated inflation and Pakistan’s efforts to restart the EFF, we think it is possible that SBP could increase interest rates by 50 bps in 2021. Seeking to achieve positive real interest rates makes little sense as private sector credit offtake is anemic and unlikely to increase in the months ahead;
  • It now appears that EFF targets could be negotiated for end-December. Pakistan is keen to resume and complete the IMF program on schedule, looking more for the endorsement than dollars.  SBP’s reserves will be at record highs with the inflow of $ 2.8 bln from the IMF’s general allocation;
  • Key things to look out for: (1) monthly imports; (2) inflation that is stoked by the weak rupee and fuel prices; (3) end-December EFF targets; and (4) what happens in Afghanistan;
  • Unlike the 1990s, Pakistan will have better company when it recognizes the new Afghan government. China and Russia have accepted the Taliban as a legitimate political party, and Pakistan will only recognize the new government alongside China, Russia, Turkey, and Iran.  However, this all depends on how events play out and whether the Taliban are able to stabilize Kabul after US troops and personnel leave the country.
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July 24, 2021

  • June’s current account (CA) deficit changes market sentiments, and signals the end of the BoP comfort that played out in FY21;
  • Driven by an import bill above $ 6.3 bln in June, the authorities must now contain imports, which could explain the recent weakening of the rupee;
  • The external sector outlook is now more challenging, which will hurt business sentiments. While the 0.6% of GDP CA deficit in FY21 is well below target, managing the external sector has become the policy priority;
  • In the larger picture, Pakistan’s twin deficit has narrowed significantly in the past two years. With a supportive budget for FY22, economic policies are consistent with the IMF stabilization program;
  • We are surprised by the negative media coverage about Pakistan’s relationship with the IMF. While the 6th review has been postponed, one must realize that Pakistan stayed on track with the EFF without any targets in FY21;
  • The better pricing in the recent Eurobond issue suggests that the local media is perhaps exaggerating the tension between the GoP and the IMF;
  • Inflation was 8.9% in FY21, at the upper end of SBP’s 7-9% target. The 8.2% target for this fiscal year is higher than the medium-term forecast and suggests that inflation will remain elevated.  A weaker rupee, rising utility rates, and higher fuel prices will keep inflation firm, but SBP will resist increasing interest rates;
  • Pakistan is experiencing a fourth Covid wave, and a post-Eid spike is playing out. The Indian (Delta) variant is rising in Pakistan and the authorities have taken steps to lock down the economy again.  With vaccinations lagging behind, hospitals in Karachi are being stressed. As the Delta variant begins to dominate, Covid fears have started growing;
  • With a sudden change in sentiments about the external sector, Pakistan’s relationship with the US has gained center stage. How the PTI government manages this relationship against the backdrop of Taliban gains in Afghanistan, will test our policymakers.  Since Pakistan has clearly sided with China (on issues that the US is using to create global pressure against China), it will be difficult to play both sides.  This will be complicated by the uncertainty created as the US ends its 2-decade campaign in Afghanistan, which will directly and indirectly impact Pakistan;
  • In our view, the recent concern about the external sector coupled with the uncertainty about what happens next in Afghanistan, are the main challenges facing the economy. While the IFIs may be more inflexible in dealing with Pakistan, they cannot appear to be partisan to US (or Western) views.  In effect, the country’s economic policies are heading in the right direction, but the challenges have just increased.
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June 25, 2021

  • Federal budget is growth-friendly and builds on a surprisingly good year. Budget forecasts 4.8% growth in FY22;
  • Unlike theories that the IMF program is off, we believe the FY22 budget has been negotiated with the IMF. We argue that the ambitious Rs 5.8 trn FBR target, the understanding that the circular debt cannot increase, and the record target for the petroleum development levy (PDL), show that the stubborn problems are to be addressed;
  • However, the revenue measures announced are wishful, especially for sales and direct taxes;
  • Budget has little to say about Pakistan’s BoP in FY22. Since the easy current account position in FY21 was instrumental in driving growth much above official targets, the lack of a handle for FY22 could undermine the government’s 4.8% growth target for next year;
  • BoP data continues to be supportive. The current account (CA) should be balanced in FY21;
  • FX reserves remain strong, but the rupee has weakened in recent weeks (Rs/$ was 158.6 on 25th June). This is undermining business confidence, and without a BoP projection for FY22, the market cannot plan for the future;
  • Remittances dip in May, but still healthy at $ 2.5 bln. We expect the year to end well, and project total annual remittances above $ 29 bln in FY21.  This $ 6 bln increase over FY20, made all the difference.  We are a bit unnerved by media reports that the government expects remittances to exceed $ 31 bln next fiscal year;
  • Since end-June 2021 EFF targets were not set, the 6th IMF review could be delayed till October. This means no hard handle to make credible projections for FY22 till this review is done and published;
  • In collaboration with the provincial governments, the federal government has recently announced that there is a fundamental agreement on creating a national electricity policy. Details are sketchy, but this appears to be the first effort to address the grass-root problems plaguing Pakistan’s power sector;
  • Covid cases are trending down with daily infections below 1,000. However, regional countries are still suffering, and travel restrictions remain strict on Pakistanis.  This impacts the country counter-cyclically: greater spread (of the infection) that results in stricter travel restrictions, works for Pakistan in terms of strong remittances; but if things improve and travel restrictions are eased, this will make it challenging for Pakistan;
  • Finally, geopolitics. The US troop withdrawal from Afghanistan is proceeding faster than expected, and there are legitimate fears that the unrest in Afghanistan will spill over into Pakistan.  While many think the US withdrawal will strengthen Pakistan’s position vis-à-vis the West, we think the net impact on Pakistan will be negative.
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May 25, 2021

  • GoP appears to have come to an understanding with the IMF, whereby Pakistan will come close to the IMF’s revenue targets for FY22, but will not increase power tariffs;
  • The FY22 federal budget expected on 11th June should provide a handle on the compromise that has been agreed upon;
  • SBP and MoF initially reject the National Accounts Committee’s 3.94% growth projection for FY21, but backtrack after IK Tweeted his satisfaction with this better-than-expected outcome;
  • Since December 2020, we have argued that Pakistan’s economic growth would be 3-4 %, which was much higher than official projections. We based this on growing non-oil imports, strong LSM growth, the uptake on TERF, and how a strong rupee improved business confidence;
  • April’s YoY inflation hits 11.1%, which is awkward for SBP. The central bank is also on the defensive because of the FM’s criticism about hiking interest rates in 2019; the Supreme Court petition against SBP’s top management; & the controversy about the amended SBP Act.  In view of this, we do not expect SBP to raise interest rates in July (and beyond);
  • The CA deficit in April is $ 200 mln, which is higher than we expected. The 10-month CA surplus is now $ 773 mln, and we predict a full-year surplus of $ 630 mln.  This improvement is driven by remittances, which have posted an inflow of $ 24.2 bln in 10 months;
  • This positive outcome does not mean Pakistan’s external sector problems have been solved. External debt payments in the year ahead still exceed SBP’s liquid FX reserves, and Pakistan is rolling over its ST dollar debts;
  • We make a strong argument that Pakistan needs to focus on import substitution. The IMF’s BoP projections show no structural improvement in the external sector but expect a growing CA deficit to be financed by FDI and fickle portfolio inflows.  By containing imports (as Pakistan has done between FY18 to FY20), the country can stop borrowing or rolling over its debt, and it can grow its FX reserves and manage the rupee in a predictable manner;
  • Pakistan appears to have crested the 3rd pandemic wave, despite a brief spike after Eid. However, given the devastation caused by the Indian variant, and the similarity between India and Pakistan, we urge caution and support the government’s proactive steps to reduce social interaction;
  • Israel’s brutal attack on Gaza City ended with a ceasefire, but the underlying problems have not been resolved. While Israel has taken such actions in the past, this time may be different because of the impact of social media and the growing frustration amongst Palestinians towards the Palestinian Authority.  It also exposes the inadequacy of the Abraham Accords and raises concern that if Saudi and the UAE ignore the plight of the Palestinian cause, this will split the Arab world.  This could create complications for Pakistan as it relies on the GCC for emergency loans and remittances.
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April 26, 2021

  • After a series of changes in the finance team, a new team under the stewardship of Shaukat Tarin has been created. After making statements against the IMF program, the new FM has become silent;
  • We interpret this as a sign that the GoP and the IMF are discussing the final shape of the EFF, which will be unveiled in the forthcoming federal budget for FY22;
  • The IMF releases its Staff Paper on April 8th. Program details show a laser focus on the circular debt problem, and the need for a multiyear tax reform agenda to remove tax concessions and exemptions;
  • Rising FBR targets from FY22 onwards, highlights Pakistan’s weak tax machinery. Furthermore, growing targets for surcharge revenues means the government will not be able to protect consumers from rising global oil prices;
  • The IMF’s focus on the autonomy of key regulators (Ogra, Nepra, SBP) seeks to reduce the government’s role in setting key prices. This means the setting of power tariffs, fuel prices, and the rupee-dollar parity, will not involve the government;
  • This may explain the change in the government’s narrative about the IMF program. We argue that both sides will stand firm, which means the ongoing negotiations will not be easy;
  • External sector data has been revised, and the CA deficit in FY20 has increased from $ 2.97 bln to $ 4.45 bln. Also, the 9-m CA surplus in FY21 has increased to $ 959 mln, after posting a deficit of $ 47 mln in March 2021;
  • As a result, we have changed our full-year FY21 projection of the CA deficit to $ 0;
  • To sustain growth of 4-5% in the next five years, the IMF projects the CA deficit to increase from $ 5.4 bln in FY22 to $ 11.5 bln in FY26. This gap is to be financed by private foreign investors (e.g., equity inflows, carry trades, and Pakistani banks borrowing from abroad).  If these inflows do not materialize, the CA will remain a challenge.  Using private inflows to finance the CA deficit is inherently risky, as shown by what Turkey is currently experiencing;
  • Inflationary expectations are being managed by controlling fuel prices and power tariffs, and by keeping the rupee strong. These measures have succeeded, but will not be allowed in the IMF program;
  • The 3rd wave of Covid-19 is alarming but is not trending up. The NCOC has been proactive to shut down schools, markets, restaurants and has told offices to limit people and working hours.  The crisis in India should be an effective cautionary tale to ensure that Pakistanis take the pandemic seriously;
  • President Biden’s decision to unconditionally withdraw from Afghanistan, has raised hope and concern in Pakistan. Some people feel this will strengthen Pakistan’s hand in dealing with the Biden Administration (with implications for our discussion with the IMF), but others think it leaves Pakistan isolated and vulnerable.  We think Biden will argue that what happens in Afghanistan is not the sole responsibility of the US, and his government will not take ownership.  This means Pakistan’s leverage will be limited.
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March 26, 2021

  • SBP’s Act has been amended to meet IMF conditions to resume the Extended Fund Facility (EFF);
  • The salient features are:
    • Controlling inflation will be the primary goal, and SBP’s development agenda will only be of tertiary importance;
    • The federal government will not be allowed to borrow from SBP;
    • The Ministry of Finance will have no say in determining interest rates or how the rupee is managed;
    • The Secretary Finance will no longer be a member of SBP’s board;
    • SBP will halt all quasi-fiscal operations on the behalf of the government, but it can continue its refinance schemes to target underserved sectors (not specified); &
    • The allocation of SBP’s profits will be solely determined by SBP’s board, which will prioritize building SBP’s paid-up capital.
  • While the thrust of these changes is positive, we think this will not serve the country well. More specifically, crowding out of the private sector will not be addressed; refinance schemes will be subservient to controlling inflation (via capping reserve money growth), and banks will further shy away from SME financing.  Banks will focus on elite clients like the GoP and blue-chip corporates;
  • This flavor of autonomy (also seen in Nepra’s mandate) seeks to pass on the cost (to the average Pakistani) of not addressing fundamental issues like insufficient tax revenues; a growing circular debt; and loss-making SOEs;
  • This IMF program entails a heavy political cost on the PTI government, as the coalition of opposition parties could use the economic hardship to attack PTI;
  • The current account (CA) deficit in February was only $ 50 mln, which is lower than we had anticipated. Nevertheless, the $ 881 mln CA surplus posted in the eight months of FY21, gives Pakistan enough room to grow the economy;
  • The anticipated rise in YoY inflation will be awkward for SBP after its newly minted mandate to focus on controlling inflation;
  • Remittances post the 9th consecutive month of $ 2bln + inflows, which is likely to continue. However, inflows from the UAE and Saudi Arabia have dipped in the past two months, which is a source of concern;
  • The autonomy of SBP and Nepra (& we expect something similar for Ogra) may reduce the government’s control on regulators, but it does not signal a tense relationship in the future. In our view, regulators will be expected to behave “responsibly” despite their “autonomy”.
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February 26, 2021

  • January’s current account (CA) deficit was smaller than anticipated (at $ 229 mln).  However, we still expect the remaining months of FY21 to post deficits as imports will remain elevated.  With a $ 912 mln balance of payments (BoP) surplus in Jul-Jan 2021, Pakistan has the room to grow imports without stressing it BoP.  We expect Pakistan’s CA deficit in FY21 to be around $ 2 bln;
  • IMF announces that the EFF will start in April 2021, but only $ 500 mln will be released for the 2nd to the 5th quarterly reviews.  This means that Pakistan was in the EFF during 2020 and the $ 1.4 bln emergency assistance provided in April 2020, has been internalized in the EFF;
  • This reaffirms our view that Pakistan’s economy has done well during the pandemic; more specifically: (1) the smooth exit of carry trades; (2) travel restrictions have boosted remittances and kept monthly inflows above $ 2 bln in the past 8 months; (3) the global focus on relief and stimulus allowed the authorities to embark on TERF; (4) the fall in oil prices helped Pakistan’s BoP; & (5) if the program ends as scheduled in Sept 2022, this means the next general elections will take place after the IMF program ends.
  • The composition of monthly imports strongly suggests that Pakistan is experiencing a growth phase.  In the past two months, non-oil and machinery imports are at record highs, while the import of CKD kits (to assemble motor vehicles) is trending up sharply;
  • Exports have bounced back sharply after the lockdown, but we are concerned that this may reverse when other textile exporters (e.g., India and Bangladesh) come back online;
  • We are surprised that YoY inflation edged down in January, especially after 4 consecutive increases in retail fuel prices and the hike in power tariffs.  This has lowered our inflation projection to 9.6% in FY21 but expect a rise in inflation in the months ahead because of the base effect.  However, we do not see SBP increasing interest rates in the period ahead;
  • We maintain our growth projection of 3-4 % for FY21, which is far higher than the IMF’s 1½ %, and even SBP’s range of 1½ – 2½ %.  We cannot explain why the IMF is so pessimistic, since business confidence is high, and imports will remain strong in 2021.  However, the growth momentum will have to be pulled back when BoP pressures begin to manifest.
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January 22, 2021

  • The streak of monthly current account surpluses ends in December, with a deficit of $ 662 mln. The reversal from a surplus of $ 513 mln in November has changed our full-year BoP projections;
  • This turnaround is driven by a $ 940 mln increase in imports in December, which can be traced to food imports (to contain food inflation) and underlying economic activity in construction and textiles;
  • This supports our elevated growth projection of 3-4% in FY21, but it does so at the expense of the BoP comfort so far;
  • Monthly remittances were strong in December ($ 2.4 bln), and should remain buoyant while travel restrictions remain in place;
  • The IMF’s full-year BoP projection will give us a better handle on currency stability and the accumulation of reserves by end-FY21. As things stand, the rupee should be stable till March and then experience some flexibility as the country transitions into the IMF program;
  • We expect the IMF negotiations to focus on familiar issues like raising power tariffs, containing the circular debt, increasing FBR revenues, and pushing for the autonomy of SBP and Nepra. We expect the EFF to restart in April with binding targets for June 2021;
  • With the recent power tariff and retail fuel price increases, we have raised our inflation projections to the upper end of the 10-11% range. The base effect will exaggerate YoY inflation in Q1-2021;
  • This may put some pressure on SBP to increase interest rates in March, but it will only be a token;
  • While Western countries have rolled-out mass vaccination programs, daily infections, deaths, and hospitalization are at record levels in the US and UK. Hence, the anticipated sense of relief from the vaccine has not materialized;
  • In Pakistan, on the other hand, the second wave appears to have peaked. With the number of currently infected under 35,000, we have a lot to be grateful for.  Also, vaccinations could start by March, but no details about the roll-out are available;
  • Tensions between the PDM and the PTI government have escalated in recent weeks, but this will not destabilize the government or have any impact on Pakistan’s economy;
  • Joe Biden becomes president with a peaceful transition of power. President Trump experienced a tragic end to his presidency, after his stunning political blunder to incite his supporters to storm the US Capitol.  Trump has now been impeached twice, has lost his standing in the Republican Party, and has alienated his support base.
  • We expect better relations with the Biden administration and will focus on how this White House handles Saudi Arabia, Iran, and India.
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