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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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November 20, 2018

  • US$ 6 bln pledge by Saudi shores up the PSX, but help from China and the UAE still awaited; 
  • Saudi Oil Facility will not reduce CA deficit – just the depletion of FX reserves; 
  • Impossible Trinity likely to dominate negotiations with the IMF, which includes the current account deficit; the exchange rate & domestic interest rates; 
  • Cannot control all three at the same time – IMF wants PKR to strike the balance.  This will be politically difficult and will complicate the fiscal side; 
  • We expect a 100 bps interest rate hike in November 2018; 
  • We hope IMF program will focus on unorthodox challenges like: the undocumented economy; undervalued real estate; price-setting driven by supply factors more than demand pressures; and increasing interest rates will not attract foreign capital inflows; 
  • Do not think IMF will take a hardline with Pakistan, and will be willing to work with China; 
  • China’s offer to discuss assistance and provide guidance should make this reform program different.  We hope this tackles the circular debt, pushes for documentation and accurate valuation of wealth, clamps down on capital flight, tweaks the FTA, formulates an Industrial Policy and strengthens state institutions;
  • TLP shakes the government and the Establishment – needs to be handled.  
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November 16, 2018

This presentation was prepared for HBL’s client events in Lahore, Islamabad and Karachi in mid-November 2018.  The main points are:

  • The strong economic growth since FY10 is not sustainable, as Pakistan’s twin deficits have risen sharply in the past two years.  Financing the deficits is not the solution;
  • At doctored papers, we have been watching the external sector since May 2017.  The current focus on financing sources (e.g. Saudi, UAE and China) is understandable, but Pakistan needs to narrow the twin deficits below 10% of GDP.  China’s approach to help is promising;
  • PKR/$ and interest rates changes since December 2017 are significant, and driven by external sector concerns – not inflation.  Issue remains how much more demand management the IMF will insist on;
  • Debt dynamics (both external and domestic) are frightening.  Policy efforts to narrow the external deficit will stoke the fiscal side via debt servicing, which complicates on-going negotiations;
  • Using the circular debt in the power sector, we show how politically difficult structural reforms are.  Despite the heavy political price of implementing real reforms, we argue that GoP has no choice now but to push ahead;
  • Monthly current account deficit in Nov and Dec 2018 are critical.  If the external gap is sufficiently narrowed, this will ease pressure on the PKR and interest rates in 2H-FY19;
  • With China’s guidance, we expect the next IMF program to tackle stubborn issues like documentation; external sector viability; the need for an Industrial Policy, and strengthening the bureaucracy and state institutions;
  • We conclude with three thoughts: (1) whether the PKR/$ is at 137-140 by end-June 2019 or at 145-150+, will have a material impact on the economy; (2) the bilateral relationship with China can be used to set a policy direction that will make Pakistan’s economy more sustainable; and (3) structural reforms will disrupt the economy and require a great deal of political will.  Any government intent on reforms must prepare for this political battle. 
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October 23, 2018

  • Finance Minister finally states that Pakistan will seek IMF support;
  • FATF visit was poorly managed by regulators/authorities;
  • Two months of good news regarding BoP, but FY18 CA deficit increases to $ 19 bln.  With global oil prices up, next 2-3 months are critical;
  • Increase in remittances not driven by fundamentals, but accountability;
  • External deficit; need to build FX reserves; and insufficient FDI, means heavy external borrowing ahead;
  • Heavy GoP reliance on SBP financing in FY19, will have to be reversed.  This will put upward pressure on interest rates, increase debt servicing, and keep fiscal accounts under pressure;
  • Do not expect a quantified IMF package till end-Nov;
  • GoP must solve the circular debt problem; push documentation and revenue generation; move towards external sector sustainability; create an Industrial Policy; and strengthen state institutions.  This cannot be done in a business-as-usual manner;
  • Khashoggi issue could change the Middle East; and undermine Trump’s strategy for the region;
  • Oil prices unlikely to spike after sanctions on Iran;
  • China will want CPEC to be transparent and succeed.
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September 24, 2018

  • Slow start by the PTI government, with some false steps that could have been avoided;
  • Recent gas tariff increase is the first right step, which seeks to reduce domestic demand;
  • PTI is seeking a middle-of-the-road approach: it has shifted the tax burden on the affluent; provided relief for the poor and concessions for exporters, but has conceded to the demands of tax non-filers (disappointing);
  • Sharp reduction in August imports (and current account deficit) is likely one-off, because it has been driven by a fall in the oil import bill.  With the current trajectory of global oil prices, Pakistan’s import bill is likely to increase unless retail fuel prices are increased;
  • Portfolio outflows are challenging: lack of policy direction; uncertainty about the IMF; & EM jitters are the main reasons;
  • Conflicting policy goals: import duties are being resisted as this would reduce tax revenues. GoP must prioritize external sector over fiscal revenues;
  • Unlikely that IMF will reverse Mini-Budget – its focus will be on chronic weaknesses (e.g. circular debt, PSEs, number of filers, fiscal cadaster, etc.).  With twin deficits at 12.4% of GDP in FY18, urgent steps are required;
  • US-China trade war gains momentum, but the impact is not widespread enough to swing the mid-term US elections;
  • Turkey and Argentina are calm, but the underlying problems have not been resolved;
  • US economy is booming but many are talking about an asset bubble.  An increase in US interest rates will hurt EM and slow global growth;
  • A global slowdown should not impede Pakistan’s export potential.
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August 24, 2018

  • Election results show unexpected stability.  PTI’s inaugural address is uplifting, but not a roadmap;
  • Bringing back Musharraf-era people may water down PTI’s clean-up agenda;
  • FM (Asad Umar) statement that Pakistan has overcome economic crisis before, does not set the right tone.  Hard steps are required to narrow the external deficit, which PTI appears unwilling to take to avoid an inflationary spike;
  • Surprise appreciation of PKR (to 124.5/$) shows that the kerb market is now driving the interbank (SBP) rate – not a good precedent;
  • Rising inflation will reinforce expectations for an interest rate hike;
  • External deficit in July hits $ 2.2 bln despite PKR devaluations and growth in exports and remittances.  Needs urgent action and out-of-the-box solutions (revisit China-Pakistan FTA and focus CPEC on exports);
  • IMF/CPEC politicized by Trump administration, but this should not stop Pakistan from securing an IMF program if GoP approaches the Fund; &
  • Turkey’s currency crisis reveals the risk of stubbornly large external deficits.  Loss of appetite for EM risk, means Pakistan’s Eurobond in FY19 will be more challenging.
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July 20, 2018

  • PKR adjustment and interest rate hike in July will have macro consequences – there appears to be no game plan.  Market expects further interest rate hike in September;
  • Inflation is heading up and could double compared to FY18;
  • PKR adjustment has also spilled over to the fiscal side;
  • Import compression and lower consumer spending will hit Large Scale Manufacturing (LSM);
  • External deficit in FY18 was $ 18 bln.  We estimate that even if external deficit is brought down to $ 12 bln in FY19, and FX reserves are at 2-month cover, Pakistan needs gross inflows of $ 27 bln this fiscal year;
  • Skeptical IFIs, iffy US relations, $ payment overhang, and rising inflation mean Pakistan needs out-of-the-box solutions for BoP and fiscal side;
  • Expect PTI economic team to give a sobering first address & negotiate an IMF bailout.  Will not be as large as requested, and will not be frontloaded;
  • Stabilization program should focus on strengthening key institutions, reforming the power sector and public sector enterprises, developing a “fiscal cadaster” and ensuring provincial support for structural reforms;
  • Trump insults Germany, the EU and British PM Theresa May and is determined to dismantle NATO;
  • Trump-Putin Summit disaster does not phase the US President.  Anti-Trump anger could help Republicans in the mid-terms and his re-election in 2020.  That will surely change the world.
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