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May 22, 2019

  • The past month has seen important changes in Pakistan’s economy:
  • 1.      New SBP Governor is experienced with IMF programs, but can he handle the public/political backlash? 
  • 2.      IMF agreement has been signed and will be put to the IMF’s board for approval.  It’s underfunded, which means debts repayments have been rescheduled (especially to friendly countries);
  • 3.      Prior actions have been taken on the PKR/$ parity and interest rates; these could complicate Pakistan’s already worrying debt dynamics;
  • 4.      The Asset Declaration Ordinance 2019 is a much sweeter that what Asad Umar was going to propose, and even easier than the PML-N version;
  • 5.      Opposition parties are gearing up to use these developments to undermine the PTI government; &
  • 6.      The current account deficit for April is $ 1.24 bln, which is higher than expected. 
  • The currency & interest rate adjustments have not narrowed the trade deficit much, and little attention has been paid to Pakistan’s stagnant exports;
  • The slowdown in LSM (July-March 2019) is driven by food, autos, metals, electronics and cement.  This shows a sharp slowdown in aggregate demand and consumer spending;
  • Fiscal gap of 5% in 9 months implies the full year gap could be above 7% of GDP.  A large part of this is being funded by SBP, which will have to be reversed in the stabilization program;
  • While the CA deficit (Jul-Apr) is $ 4.3 bln lower than in FY18, further narrowing is required.  We project the external gap to be $ 12.8 bln this fiscal year, which may have to be slashed to $ 4 bln in FY20.  The trade deficit has only narrowed by $ 1.9 bln, which is disappointing;
  • If further devaluation of the Rupee and higher retail fuel prices are required to narrow the external deficit, this could boost inflation to 17-18% in FY20.  The current economic challenge is perhaps unprecedented;
  • Given the CA contraction that is required, policies alone may be insufficient.  Pakistan needs an anti-import campaign, to move towards import substitution and to change CPEC to become more export-oriented;
  • Interest rate increases should be capped as this could dig the country deeper into the debt trap;
  • We are concerned about the sidelining of Y. Dagha (Finance Secretary) and FATF’s assessment of the generous amnesty scheme;
  • We expect tough policy measures before the forthcoming budget, and are concerned that the finance team may have over-committed in the next IMF program.  A stalled program would put Pakistan on a perilous path.
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April 24, 2019

  • Asad Umar’s resignation is poorly timed and could delay the IMF program;
  • In our view, his ouster was engineered from within PTI, which reveals a possible shift in policymaking away from PTI’s ideology.  We think the amnesty scheme may have been the pretext to remove the FM;
  • IMF mission to visit Pakistan in end-April, which should finalize the next program;
  • FX reserves have increased because of the $ 3.2 bln borrowed in March 2019;
  • World Bank’s projections show a somber outlook for FY19 and FY20, with low growth and high inflation;
  • IMF projections, on the other hand, are absurd: they reflect no stabilization program for the next five years, and yet also show that Pakistan is able to finance growing twin deficits without losing macro stability;
  • Autos and construction continue to slow industrial growth;
  • Single Treasury Account will be resisted by weak banks, but is required to sharply reduce GoP borrowing from the central bank;
  • Banks are rightly concerned about the repercussions of a further interest rate shock;
  • Pakistan’s BoP narrows compared to FY18, but the real reason is that import numbers for FY18 have been revised upwards.  Now the current account deficit in FY18 is $ 19.9 bln compared to $ 19.0 bln;
  • No perceptible change in Pakistan’s trade flows this year, which means policy efforts to narrow the trade deficit have not yet worked;
  • We think the current account deficit this year could be contained at $ 11-12 bln (compared to $ 20 bln in FY18), but this will have to be brought down further to $ 7 bln in FY20.  The required import compression will keep growth around 3% for the next two years;
  • The amnesty scheme that was to be announced by Asad Umar has been rejected as “too complicated” by the new Finance Adviser.  We think this means it was too harsh/punitive to tax evaders.  We also sense the IMF will have serious objections to the moral hazard problem this creates for tax-abiding citizens;
  • We see Asad Umar’s departure as symptomatic of the vested interests regaining the upper hand in policymaking.  This does not bode well for the forthcoming IMF program. 
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March 18, 2019

Updated: 25 March 2019.  

  • IMF mission head to visit on March 26.  Change in GoP’s narrative reveals that programs details will be discussed & could be finalized.  As we have discussed earlier, this should change how the PKR is managed;
  • World Bank document Pakistan@100 discusses how Pakistan could become a $ 2 trillion economy by 2047;
  • But this requires a change in the policy making process, which WB thinks has been “captured” by self-serving elite interests.  This is uncharacteristically blunt for an IFI;
  • Report identifies and lists these groups as: (1) civil servants; (2) landowners; (3) industrialists; and (4) the military.  It also talks about how these groups have become an established part of Pakistan’s political system;
  • Small current account gap in February 2019 is heartening news (and bring some relief to the FX market), but additional steps are required to further narrow the external deficit.  In the 8 months so far, the trade deficit has only narrowed by 2.8% (compared to FY18) despite large PKR adjustments and the increase in interest rates;
  • Most of the CA narrowing is because of lower services net payments & higher remittances;
  • IMF program details should be published before it begins, and we expect the current account deficit to be around $ 12 bln for FY19, and even lower in FY20;
  • Trade flows (quantum and composition) are very similar to last year, which could explain why policymakers are talking about further steps to address the BoP problem;
  • With a lagged impact, Pakistan’s oil import bill should be low in the next several months, which is an ideal time to allow the PKR to adjust according to market forces;
  • SBP has downgraded its growth projection to 3½ – 4% in FY19; we stay with our earlier estimate of 3%;
  • A flexible exchange rate may require supportive interest rates.  We suggest a short-term interest rates hike when the PKR is floated, but rates should be reduced once the PKR has stabilized;
  • While BoP actions seem clear enough, little has been done to increase fiscal revenues.  We think this is strange, and expect greater policy focus on the fiscal side as part of the IMF program;
  • We also do not see a serious game-plan to fix loss-making PSEs.  We intend to get into this area of research as it will become increasingly relevant; &
  • PM has stated that reducing Pakistan’s debt stock will become the PTI government’s key KPI.  This could signal the change in narrative, which is required.
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March 07, 2019

This presentation was specifically prepared for a discussion at HBL, with its senior management and stakeholders.  It builds on recent papers and presentations that have been shared with our clients. 

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March 04, 2019

This partial equilibrium assessment is anchored on supply-push factors that determine inflation in the country.  More specifically, we argue that the urgent need to narrow the trade deficit (given the ineffectiveness of past policies) implies that the currency would have to be further adjusted (and less strictly managed) and retail fuel prices would have to be increased. 

These price adjustments would directly impact the food, utility and transportation sub-indices, which account for over 70% of the CPI basket.  We project YoY inflation could be 12.4% by end-June 2019, while average inflation for the full year (FY19) could settle at 8.0%.  This inflationary momentum would remain in play till mid-2020.  We argue that the IMF program (and prior actions) would stoke the inflationary trend, but this is the lesser of two evils.  The real concern is what happens to interest rates. 

We argue that an orthodox approach to stabilization (i.e. increasing interest rates to keep pace with rising inflation) would: (1) create more debt servicing pressure; (2) keep the country’s market debt primarily in 3-month T-bills; (3) force GoP to continue borrowing from SBP; and (4) threaten commercial banks’ balance sheets.  None of these would help stabilize the economy. 

This creates an awkward trade-off: policy orthodox vs. actual stabilization. 

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February 20, 2019

  • Visit by the Saudi Crown Prince (MBS) is a lavish affair with MoUs worth $ 21 bln, but this doesn’t change market sentiments;
  • Repayments in 2019 are $ 21.3 bln compared to $ 13.5 bln in 2018, which reflects the spate of borrowings in 2018;
  • We expect a change in PKR/$ management – before IMF program announcement – as past efforts to rehabilitate the external sector have not delivered results;
  • Current Account target of $ 14-15 bln is an improvement over FY18 (at $ 19 bln), but this gap is still too large to calm the FX market;
  • January 2019 external deficit ($ 809 mln) brings some relief, but this growth-and-stabilization strategy will not rehabilitate the external sector;
  • January’s external gap narrowed primarily because of an increase in remittances.  Despite frequent devaluations and interest rate hikes, the trade deficit in the 7 months of FY19 is actually larger than the same period in FY18;
  • Aggregate growth will slump in FY19 on the back of negative growth in LSM (in 1H-FY19), and a greater emphasis on stabilization in 2H-FY19;
  • Intra-year data shows that debt dynamics in FY19 will post exponential growth (in both domestic and external debt) over FY18;
  • Soft oil prices will not be enough to manage the external deficit.  There is an urgent need to reduce non-oil imports, which means a further squeeze on economic activity and growth;
  • In Scenario 1 (managed PKR adjustments), inflation could rise to double-digits, but this may not change sentiments in the FX market;
  • Scenarios 2 & 3 (less intervention by SBP) will create currency volatility, which is perhaps required to change business sentiments.  There is a need to sideline importers;
  • The government’s narrative on the economy must now focus on stabilization, which means sharply narrowing the twin deficits;
  • We see the need for a degree of currency volatility but do not see much of an increase in interest rates.  Even if the IMF program starts in the next few months, the hard stabilization targets will be left for FY20. 
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January 30, 2019

This presentation was given to familiarize a visiting delegation from Mitsubishi Corporation about Pakistan’s economy. 

  • Pakistan’s growth has been on an upward trajectory since FY10, but the last two years were unsustainable;
  • There are four major weaknesses in Pakistan’s economy: (1) lack of documentation, which means low taxes; (2) failure to increase and diversify Pakistan’s exports, which means BoP problems; (3) weak institutions and pervasive corruption; and (4) extractive governments and short-term policies;
  • Stubborn twin deficits have created a significant debt overhang, which will entail painful policies to resolve.  Pakistan is now firmly in an external debt trap;
  • Fiscal deficit in FY19 will remain high, it may even exceed the 6.6% of GDP realized in FY18;
  • Industry has been stagnant at 20% of GDP for over 2 decades.  For a country of Pakistan’s size, sustainable growth requires a vibrant industrial base (reveals a lack of policy vision);
  • Previous government ignored and exacerbated the structural problems in Pakistan’s tradable sector.  More specifically, the stagnation in exports;
  • Hard steps have been taken on the PKR/$ and interest rates, but GoP is still giving mixed signals about the IMF;
  • Recent fall in SBP’s FX reserves is not just because of the size of the current account deficit, but the inability to secure sufficient financing;
  • CPEC could become a blueprint for Pakistan’s industrial policy, which will give this country an economic vision that has been missing for over three decades;
  • As things stand, there is a need to take action on the following fronts: (1) documentation of all financial/economic transactions; (2) make real estate valuations more accurate; (3) strengthen state institutions; and (4) restructure PSEs by severing the links with line Ministries.
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January 24, 2019

  • The FM’s second mini-budget announced on 23 January is populist, strategic but ultimately not serious;
  • Despite the revenue shortfall in FY19, there was no focus on revenue measures;
  • Also, there was nothing about how Pakistan’s current account deficit would be brought under control;
  • Instead, the GoP announced concessions for non-filers to buy cars and property, while the stock market was given tax relief;
  • The market may experience a short-term uplift, but without addressing the fundamentals (twin deficits), the economic uncertainty will remain;
  • 1H-FY19 external deficit was $ 8 bln, which makes the full year $ 13 bln target a policy challenge.  However, with a perceptible slowdown in economic activity and soft oil prices, we expect 2H-FY19 to post a much smaller deficit;
  • Export stagnation despite policy support is disappointing – in 1H-FY19, Pakistan’s oil import bill was 68% of total exports;
  • The rapid depletion of SBP’s FX reserves is not because of the size of the current account deficit, but reduced financing on a month-to-month basis;
  • Lop-sided GoP borrowing from the banking system, shows that banks still anticipate a further increase in interest rates;
  • We argue that the GoP’s communication strategy must be upgraded to better manage the market’s expectations;
  • We conclude by saying that GoP must come clean on stabilization measures and the forthcoming IMF program.  Only this will calm the market and instill some confidence in the economy;
  • Global conditions will remain challenging with China’s slowdown, Brexit, intra-EU tensions & US political stalemate and possible market correction. 
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December 21, 2018

  • 30 November changes in the PKR and interest rates surprised all, with FM and PM on the defensive;
  • Confusing signals about IMF despite these significant policy changes;
  • January mini-budget could focus on documentation; real estate valuation; plan for overseas assets; and full year projections for BoP and fiscal accounts;
  • PKR and interest rate changes have been significant: do not expect much more – could see token changes before program begins;
  • Oil prices and strong remittances should help contain CA deficit in 2H-FY19 ($ 13 bln full-year doable);
  • Should not see disruptive stabilization like Egypt’s in 2016;
  • Need to strengthen Debt Management Cell to shift market debt to longer-term instruments;
  • Unmistakable & unprecedented steps to regularize the undocumented sector.  This may slow growth to 3-4% (or even lower), because this will spillover to formal sector;
  • This slowdown is necessary to document economy.  GoP should take additional hard steps on power, FCAs, real estate valuations and retain penalties on non-filers.  PTI government should stay the course despite economic pain;
  • US, UK and EU are likely to experience an unsettled 2019 (economically and politically);
  • China’s economic slowdown is very real, and Saudi Arabia could see a change in leadership in 2019. 
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December 13, 2018

This presentation was prepared for Engro Corporation, to assist with its planning for 2019. 

  • Uncertainty about IMF program is being stoked by a misleading distinction between “good” and “bad” IMF programs.  Markets need to be carefully managed, especially after an eventful November 30;
  • On this day, interest rates were increased by 150 bps, which exceeded market expectations.  However, after the currency turmoil in the first few hours of November 30, this increase made sense;
  • But this does not signal the end of the tightening cycle;
  • We hope that Pakistan’s stabilization is not as disruptive as what Egypt experienced in late 2016.  With unhinged market expectations, a free-floating PKR could be too destabilizing;
  • Quarterly targets on net international reserves (NIR) and Pakistan’s primary deficit, are likely to be the more binding targets in the next IMF program;
  • PKR adjustments and consecutive interest rate hikes should help reduce imports, while soft oil prices and strong remittances should further narrow the current account deficit.  A $13 bln external deficit in FY19 is possible without disruptive policy measures;
  • We expect average inflation in the range of 8-9%, and interest rates around 11-12% by June 2019.  Import compression and a subdued informal economy could push down growth to 3-4%;
  • Forthcoming policies could dampen the undocumented economy via: the accountability drive; the anti-encroachment efforts; the distinction between filers & non-filers; the effort to expose overseas Pakistani assets and the policy to push for more accurate real estate valuations.  This may bring short-term pain, but should pave the way for medium-to-long term prosperity;
  • Despite the geopolitical flux, Pakistan is not as vulnerable as many think. 
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