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• 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?

• 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.

• 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.

• 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.

• 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.

• 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.

• IMF mission arrives and shares the Memorandum of Economic & Financial Policies (MEFP). Staff-level agreement is when the authorities sign the MEFP. IMF Chief signals that Pakistan must bring more people into the tax net, and hints that there is no plan for debt forgiveness;
• Dar lets the rupee go on 26 January, which moves from 230.7/$ to 275.2/$ on 3 February, but has gained some ground. It triggered sales from exporters who were holding back;
• A minibudget was announced on 15 February and included many prior actions. Gas & power tariffs have been raised; GST has increased to 18%; fuel prices were hiked; luxury tax was imposed; and FED is charged on sugary drinks, cigarettes, and business class air travel. Dar claims the IMF has agreed not to impose GST on fuel;
• These steps will spike inflation, and our projections show that average inflation in FY23 will be just above 30%, while food inflation could average 40% in the year;
• FX reserves keep falling, dipping below $ 3 bln in early February. BoP data shows that SBP has lost over $ 7 bln from July to January 2023. Even if the EFF restarts, the next tranche of $ 1.2 bln may not be released till mid-March;
• Remittances continue to fall, reaching $ 1.9 bln in January from a recent high of $ 2.7 bln in August 2022. However, with a more realistic rupee parity, we think remittances will increase in the months head;
• There is much talk about an emergency MPC to hike interest rates – this may be a prior action. We expect a 200 bps rise in the coming days. Further increases will depend on whether the IMF imposes a ceiling on outstanding OMOs;
• January’s current account deficit (CAD) was $ 242 mln, only 10% of the deficit in January 2022. Non-oil imports are down 32% in the seven months of FY23 compared to FY22, which shows the squeeze on the real economy;
• BoP data shows that in these seven months, the Financial Account posted an outflow of $ 3.2 bln compared to an inflow of $ 11.6 bln in the same period in FY22. Service payments were only $ 301 mln compared to $ 2.7 bln last year, as SBP has stopped making service payments;
• Imports show a sharp fall in auto parts and oil, but food imports remain elevated. Textile exports also post a steady decline;
• We argue that the rise in public anger makes it unlikely that PDM will remain a united coalition, which raises the possibility of Plan B (a three-year interim government to focus on the economy and stay on track with the current EFF and the next EFF);
• Since only IK (and PTI) will lose with Plan B, IK has stepped up his attacks on Retr General Qamar Bajwa as a way of putting pressure on the army not to delay elections;
• We also argue that all external stakeholders would prefer Plan B as this will ensure that Pakistan does not experience an economic and social collapse. Since these stakeholders are now calling the shots ($s and IMF seal of approval), their interests may prevail.

• IMF demands are precise: (1) fix the exchange rate; (2) increase power and gas tariffs; (3) release a minibudget with new revenue measures; and (4) impose GST on fuels;
• GoP is now saying it would like to negotiate these conditions with the IMF. Negotiating prior actions is a non-starter, which means this is political spin: beg the IMF mission to visit Pakistan, and then adjust the rupee, and deflect the blame onto the IMF;
• SBP has revoked the approval stage for LC confirmations, effectively shielding it from criticism and shifting the blame onto commercial banks. This may further squeeze LCs, as banks become more cautious about committing to $ payments when they know that SBP will not help;
• The sharp reduction in imports has triggered widespread layoffs and is angering businesses across the country. Non-oil imports have dropped by almost 30% in 1H-FY23 compared to the same period a year ago;
• The kerb premium could be as high as 35-40/$ and will require a one-shot adjustment. This will spike inflation and trigger public anger;
• The kerb premium is shifting remittances to the kerb market and delaying export receipts. SBP’s exchange rate policy has failed, but the central bank appears powerless to change it while Dar is in charge;
• Imposing GST on fuels will be politically difficult and expose the lie that GoP wants to restart the EFF but not burden the common man;
• FX reserves continue to fall despite a declining external deficit. In the past 18 months, SBP’s reserves have fallen by almost $ 12 bln. Pakistan’s BoP problem is now structural and cannot be solved without comprehensive debt restructuring;
• Inflation is likely to experience a surge when the IMF’s prior actions are implemented. Food inflation could average 34% in FY23 and exceed 40% YoY in February 2023. Food inflation has already become a national crisis and could have dire political consequences for PML-N;
• Instead of guiding the economy, GoP and SBP are finding scapegoats and resorting to political spin. This inaction will not only anger the business community (which is PML-N’s vote bank) but also result in nationwide shortages of essential items – this has played out in Sri Lanka;
• Since the economic team has lost all credibility, the best hope is an empowered caretaker setup that declares a state of emergency and restarts the EFF. We are surprised the establishment is so passive when the country is facing an unprecedented economic/political crisis;
• With the dissolution of the Punjab Assembly and KP likely to go the same route, domestic politics remains a mess. PML-N is fighting for its political survival, but its inaction on the economic front could be the final nail in its coffin.

• There is no clarity on Pakistan’s relationship with the IMF. The 9th review will be delayed till January 2023, which means the next tranche may be delayed till February;
• We expect tensions on the growing circular debt, the strict management of the rupee, insufficient tax revenues, and the delay in imposing GST on fuels;
• While Dar continues to say the economy is moving towards stability, the State Minister of Finance has recently admitted that things are not well. A social media story listing nine emergency measures goes viral, which reveals that the market expects emergency steps soon. The artificial calm projected by policymakers is undermining business confidence;
• Strict import curtailment is choking the domestic economy. In the first five months of FY23, non-oil imports are down 29% compared to FY22, with reports of widespread layoffs as manufacturers reduce shifts because of inadequate imports;
• The government is taking no steps to rethink its external debt. Debt repayments between Nov 2022 to Oct 2023 are over $ 26 bln compared to less than $ 6 bln in late 2017. SBP is trying to shore up confidence by listing $ inflows and outflows in FY23, and arguing that arrangements are in place to meet all $ repayments (while strictly limiting import LCs);
• The current account deficit in November shrinks to $ 276 mln, which means the full-year CAD will be smaller than projected. However, with remittances edging down (distortions in the FX market) and a poor outlook for exports, the BoP problem remains. With SBP’s FX reserves falling to a four-year low, the market cannot shake off fears of default;
• Getting on track with the EFF will be difficult. We expect prior actions on: FX management; GST on fuels; power tariff increases; and some steps to target loss-making SOEs. This is politically unpalatable, which explains the government’s muddled outlook;
• We list eight necessary structural reforms that will be difficult to implement. We wonder if the IMF may seek some guarantee that these measures will be taken (via a charter of economy type arrangement);
• Global oil prices are unexpectedly soft despite the price cap on Russian oil exports. With winter getting worse in Europe, we fear that oil prices could start climbing;
• IK announces 23rd December as the date for the dissolution of the Punjab and KP governments. This will energize domestic politics but do little to provide an economic roadmap.

• Frantic political developments dominate in November. Army felt compelled to counter misinformation in an unprecedented press conference by the ISI chief;
• There was an assassination attempt on IK on 3 November, in which he was injured. One was killed, and 14 were wounded. IK accused Shehbaz Sharif, Rana Sanaullah, and a senior ISI officer for the attack, but could not name them in the FIR. IK also mentioned a second shooter, which the government has dismissed;
• Anticipation is building on the choice of the next COAS. Commentators claim that the decision will determine whether early elections are held, which may provoke a political reaction;
• Dar is trying his best to calm market fears of sovereign default but to no avail. 5-year CDS spreads signal pending default with only weeks till the 5 December Sukuk maturity. The fact that the IMF and MBS (of Saudi Arabia) have delayed their trips to Pakistan adds to the sense of despair;
• Analysts claim the 9th review will be delayed till December, and even if the negotiations are successful, the next tranche will not be released till January 2023. In our view, approval will require prior actions that could be painful;
• The IMF is not convinced about the flood-related economic damage proposed by the authorities. Hence, the Paris donor conference has been delayed. Four months after the deadly floods, international assistance for humanitarian assistance is already too late;
• Inflation remains elevated, with October’s YoY increase at 26.6%. Our projection for average inflation in FY23 is 28%, based on a potential rise in oil prices in December/January and a weaker rupee when the 9th review begins. We argue that inflation is a slow burn, and the loss of purchasing power and increase in poverty could have political repercussions;
• October’s CAD comes in at $ 567 mln, which shows that SBP’s import restrictions are working. However, the 27% fall in non-oil imports in Jul-Oct 2022 (compared to a year before) shows that the economy is being squeezed;
• The exorbitant kerb premium is reducing monthly remittances and creating unease about the artificial strength of the rupee in the interbank market. This could sour the negotiations with the IMF;
• The pending decision of the COAS, the 26 November PTI show of force, and the maturity of the Sukuk, means the next two weeks will be uncertain. One thing is clear, however, political clarity is now a prerequisite for economic clarity.