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February 24, 2022

  • $ 2.56 bln current account deficit (CAD) in January is a record high and has shocked the market. Compared to $ 1.8 bln in December 2021, this was primarily driven by a fall in both exports and remittances;
  • This makes the $ 13 bln CAD target for FY22 unachievable and will require tweaking the EFF targets. The IMF may concede that the sharp increase in oil prices is beyond the control of member countries, but it may not provide much leeway on other program parameters;
  • February 2022 IMF Staff Paper anchors Pakistan’s economic outlook:
    1. 6th Review covers the period till June 2021, which means performance targets for March and June 2022 are likely to change;
    2. The IMF projects inflation at 8.9% in FY22, but this is likely to be revised upwards;
    3. IMF has added 6 new Structural Benchmarks (SBs) to the EFF that must be met by June 2022. Two will be difficult: (1) shifting all SBP refinance schemes into a new DFI; and (2) parliamentary approval of a new state-owned enterprise (SOE) law.  We expect resistance from business elite and politicians;
    4. The IMF has given Pakistan 12 months to retain import margins and restrictions on forward cover till its BoP position stabilizes; &
    5. Unlike the government’s perspective that BoP pressures come from global commodity prices (especially oil), the IMF places most of the blame on strong import growth fueled by strong domestic demand. The latter can be traced to expansionary fiscal and monetary policies implemented during the Covid lockdown.
  • In view of the IMF’s tone, we expect SBP to increase interest rates in March 2022, despite an earlier signal that it would “pause” on further rate hikes;
  • With Brent crossing $ 105/b, further hikes in fuel prices are expected. The resulting public pain and anger will keep the PTI government on the defensive;
  • Large CADs since October 2021 have not been reflected in the rupee parity, but this is likely to change in the months ahead;
  • Our inflation projections for FY22 have been increased to 12.4% (average) and could go as high as 16% (YoY) in June 2022;
  • Pakistan has crested the 5th Covid wave, and it appears the Covid fear (globally) has receded significantly. Pakistan has done very well given the size of its population;
  • Opposition parties have a lot of ammunition to remove IK as Prime Minister, but given the difficult economic outlook, they would rather let PTI shoulder the blame than take ownership for the economy; &
  • Russia’s invasion of Ukraine did not surprise the world, but the mounting fatalities and uncertainty are shaking the global order. Sanctions have not deterred Putin, and his fiery words reveal that he is willing to step up the conflict rather than seek a settlement.  With the world split into the US and Sino-Russian camps, IK’s visit to Russia will reinforce the impression that Pakistan is aligned against US interests.  This is risky as Pakistan is dependent on the EFF, and the IMF is likely to play hardball.
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January 23, 2022

  • Two key Bills (mini-budget and SBP) are approved by the National Assembly, after a noisy and chaotic 7-hour session attended by the top leadership of all political parties;
  • This paves the way for the EFF, which should be a source of comfort for the economy;
  • PBS rebases its GDP data using 2015/16 as the base year. As a result, FY21’s 3.9% growth using the old base is upgraded to 5.4%, while the new base shows the growth at 5.6%.  We are not surprised by the upgrade, as the stimulus-based economic boost was concentrated in the large businesses;
  • December’s current account deficit (CAD) hits $ 1.93 bln, raising concern about the external deficit and what is required to bring this under control;
  • Oil, autos, and food imports are driving the CAD to unsustainable levels, as measures to pare down imports have not succeeded;
  • Exports perform well in December, but this will not be able to reverse the sharp increase in the external deficit. Pakistan’s BoP has become its most pressing policy challenge – again;
  • Except for lumpy inflows (IMF allocation and Saudi placement), SBP’s FX reserves continue to fall. We are surprised that SBP stabilized the rupee after 10th December even though the underlying deficit was still so large;
  • Pakistan is rushing to issue a $ 1 bln Sukuk even without the formal approval for the EFF – this could be driven by the persistent fall in FX reserves;
  • With elevated Brent crude prices, removal of GST exemptions, and rising utility rates, inflation will continue to increase well above SBP’s 9-11% range for FY22. Furthermore, the measures that will be taken as part of the Finance (Supplementary) Bill, will add to higher retail prices.  Opposition parties are using inflation to drum up public rage against the PTI government;
  • Prime Minister Imran Khan’s warning that he would be more disruptive outside the government, is a clear indication that there is growing pressure against his government, which may not complete its full term;
  • The fifth Covid wave has hit Pakistan hard, breaking records for the speed of transmission and daily infections. Fortunately, the less virulent Omicron variant has kept fatalities down and the government is not considering strict lockdowns but smart containment;
  • The Russia-NATO standoff could turn hot, while the drone/missile attacks on the UAE reveal that the détente with Iran is over.
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December 21, 2021

  • GoP moves on key prior actions like the mini-budget and the SBP Bill 2021, but details of the latter are not public;
  • There are rumors the IMF board meeting could be delayed as GoP has postponed a cabinet decision on the Finance Bill and the SBP Bill. While we think these will be approved (with some grandstanding in parliament), the delay will put pressure on SBP to manage market sentiments;
  • Media reports suggest that hard steps are being taken to impose a 17% GST on 140 items while reducing the discretionary power of senior customs officials. These are positive steps, but will carry a political cost (this will stoke inflation and reduce corruption);
  • SBP hikes rates by 100 bps and says it will pause in the near future. While the intention is to keep banks from pushing market rates any higher, commercial banks will react to inflation and the external deficit and are likely to keep pushing SBP;
  • The CAD in November is $ 1.9 bln, which is smaller than the market’s expectation. This is because PBS data shows imports at $ 7.9 bln, while SBP claims it was $ 6.4 bln – there is no clarification about this significant discrepancy;
  • SBP hints at a full year CAD of $ 13-14 bln in FY22 but does not specify the target. Even if the full year CAD is $ 13 bln, the external deficit will have to be brought down sharply in 2H-FY22.  SBP also revised its inflation projection to 9-11%;
  • Rising inflation (especially food inflation) has become the main policy concern, but little can be done to control it as retail fuel prices are expected to increase further;
  • Challenges continue to pile up: the rupee-dollar parity; the fall in FX reserves; OMO injections as SBP tightens domestic liquidity; $ debt servicing; the increase in fuel prices even if Brent crude remains soft; and the fall in worker remittances as international travel begins;
  • The import pressure from the monetary stimulus has been compounded by rising commodity prices (foods and fuels). While textile exports posted a record high in November 2021, this is not the case for net textile exports;
  • Afghanistan remains a challenge and there is no roadmap of what lies ahead;
  • IK skips President Biden’s Democracy Summit, which shows that Pakistan is aligned with China;
  • Economic pain and political uncertainty make this the most challenging period for PTI. Opposition parties do not appear keen to force a change in government, which could reflect their concern that managing the economy will cost them political capital.  The outlook for PTI in the 2023 elections is not good.
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November 20, 2021

  • After a month of uncertainty about the IMF program, a staff-level agreement has been reached with 2 key prior actions – parliamentary approval for the SBP Bill and the Finance Bill. The latter will translate into a mini-budget, which will focus on GoP’s taxation plan for FY22;
  • A min budget is required as the government has been double-minded about passing on the increase in global oil prices to retail consumers. Despite the sharp increase in fuel prices in the last two months, further increases are likely;
  • The SBP Bill has been politicized and there is a risk that it may not be passed. The revised Bill has not yet been released to the public;
  • October’s current account deficit (CAD) is $ 1.66 bln, which is higher than expected. The 4-month CAD of $ 5.1 bln cannot be sustained in the rest of FY22, which means the authorities will have to step up their efforts to reduce imports in the remaining part of the fiscal year.  We still await the IMF Staff Paper to know the size of the full-year CAD the authorities have agreed to;
  • Import data reveals that while non-oil imports have plateaued and could fall in the months ahead, oil and food imports will continue to trend up. This means monthly imports will not fall as sharply as the authorities hope for;
  • Furthermore, remittances have dipped in October, and if foreign travel starts with the easing of covid restrictions, this could add further pressure on the CAD;
  • SBP increased the cash reserve requirements (CRR) from 5 to 6% in an effort to reduce domestic liquidity. This is expected as a prelude to restarting the EFF, but since SBP has been injecting about Rs 2 trn short-term liquidity into the system, we expect the EFF to also focus on reducing the liquidity that SBP is injecting into the system;
  • With monthly data releases for inflation and the CAD, the stream of bad news is likely to continue. Not only could this impact the rupee (and business sentiments), but also generate public anger.  This will translate into political pressure against the PTI government;
  • Cooling relations with the US after the Taliban takeover of Afghanistan remains a source of concern. Pakistan’s global image has been further tainted by the negotiations between the government and banned groups like the TTP and TLP;
  • With Pakistan’s structural problems in the external sector once again in the limelight, we argue that the only way to break out of this impasse is to focus CPEC 2.0 on generating hard currency via a new set of exports or playing a transit corridor role for regional trade flows or saving hard currency via import substitution.
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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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