GoP's mixed signals, the IFI's clarity & the task ahead

(April 11, 2019)

Business sentiments are confused.  PTI has been in power long enough that it now owns the economic mess left behind by the PML-N government.  But there is some anger about what exactly this government seeks to achieve: the FM claims that Pakistan has the upper hand in the IMF negotiations, which suggests an easy stabilization program; concessions to tax non-filers signals an about-turn; the FM says further devaluation is not necessary, yet the kerb market is under pressure; and the FM talks about the need to float the currency, and is surprised when the kerb market panics.  In this confusion, opportunistic moneychangers are seeking to self-regulate the kerb market, which would be nothing short of a disaster. 

On the other hand, the IFIs have put forward a more somber and realistic outlook for the future.  All IFIs predict slower growth in FY20, with the World Bank showing a sharp curtailment of the external deficit and an increase in inflation in FY20 (presumably because of a stabilization program).  It also predicts an alarming increase in Pakistan’s debt-to-GDP ratio, showing an increase from 73.5% in FY18 to 82.3% in FY19.  In an assessment of the debt carried by a group of 40 peer countries, the IMF shows that Pakistan has the shortest maturity; the second lowest revenue stream; the largest portion of its debt maturing in any given year; and is likely to post the sharpest debt/GDP increase in the next several years.  Our calculations show that if the external deficit narrows from $ 12 bln in FY19 to $ 7 bln in FY20, SBP manages to roll over all FX swaps, and retains the same level of FX reserves; Pakistan would need $ 23 bln during the period March 2019 to February 2020. 

We talk about the amnesty scheme that PTI is considering, which is tougher that what PML-N announced in its last year in power.  While we endorse this approach towards amnesty, we conclude by saying that several factors should help the government take hard steps on the economy: (1) the sheer magnitude of problem that has to be overcome; (2) that PTI is a new force in the country’s political landscape; and (3) China.  Policymakers need to think out-of-the-box and find a customized solution to Pakistan’s overwhelming economic challenges. 

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Perspective on Pakistan's external sector

(March 15, 2019)

This illustrated paper uses a PowerPoint format because of its heavy use of data. 

This paper puts Pakistan’s BoP crisis into context.  It argues that the problem first manifested in FY17, and unlike previous economic challenges, this one was engineered by the previous government’s short-sighted exchange rate policy.  Despite significant PKR adjustments since end-2017 (and interest rate increases), the country’s trade deficit and patterns of trade, have not changed much.  To alter sentiments in the FX market, policymakers will have to allow the PKR to find its own level with minimal intervention by the State Bank of Pakistan – we suggest several policy measures to make the transition less disruptive.  Policymakers must also commit that this is a paradigm change and not a short-term stabilization measure. 

Data shows that the remarkable growth of remittances after 9/11, allowed the authorities to increase imports without a commensurate increase in exports – however, this imbalance became increasingly problematic after FY12.  The tipping point came in FY17, when remittances plateaued but the net balance in goods and services exploded.  Overcoming this external imbalance will be much harder than the stabilization programs of 2008 (with the PPP) and 2013 (with the PML-N). 

Even with soft oil prices, policymakers need to reduce the quantum of oil imports; a more flexible exchange rate should also help reduce non-oil imports.  In our view, policymakers need to target a current account deficit in the range of $ 6-8 bln per annum, and not $ 12½ bln and $19 bln as posted in the previous two years.  GoP should also consider import substitution (especially for basic food imports) and understand why non-traditional exports have stagnated over the past 15 years.  In terms of jumpstarting textile exports, we propose learning from past failures, and propose teaming up with China to enter its global supply chain.  Pakistan needs to reorient its tradable sector, even in the face of stiff resistance from the status quo. 

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A Primer on Pakistan's Inflationary Trajectory53

(March 04, 2019)

This illustrated paper uses a PowerPoint format because of its heavy use of data. 

We focus on supply-push factors that determine inflation.  More specifically, we focus on administered prices like retail fuel prices, the PKR/$ parity, and power/gas utility rates, to project what could happen to inflation in the coming year.  To generate the inflationary momentum, we assume the following:

·        Jan 2019:   PKR/$ at 138.26, and petrol prices at 91.0/litre (realized);

·        June 2019: PKR/$ at 156.13, and petrol prices at 101.2/litre;

·        Sept 2019:  PKR/$ at 160.75, and petrol prices at 104.5/litre; &

·        Dec 2019:  PKR/$ at 157.53, and petrol prices at 106.9/litre.  

By June 2019, our model shows that YoY inflation will be 12.4%, while the 12-month moving average rate would be 8.0%.  While this may appear alarming, we remind the reader that inflation was abnormally low during the period mid-2014 to mid-2018 because of the collapse of oil prices in 2014.  For a country like Pakistan, which is running twin deficits above 10% of GDP, average inflation should be in the range of 7% to 9%. 

We show that food inflation (which accounts for 34.8% of the CPI basket) could hit double-digits from June 2019 to January 2020.  The utilities sub-index (which accounts for 29.4% of the basket) is already close to 12% (YoY) and will continue to increase.  Finally, transportation (which accounts for 7.2%) is already at 13% and will stay at elevated levels (12-17% YoY) till September 2019.  We then argue that other sub-indices will follow suit as retailers will look at administered prices to influence their own price-setting behavior.  We urge policymakers to bite the bullet and increase administered prices to narrow the twin deficits, acknowledging that stabilization will stoke inflation. 

The policy challenge is what to do with interest rates, as the market needs comfort that the monetary tightening cycle had ended (this is necessary to increase the maturity of Pakistan’s domestic debt).  In effect, Pakistan faces an awkward policy choice: policy orthodoxy (increase interest rates to combat rising inflation) vs. actual stabilization.  In our view, orthodoxy will not allow Pakistan’s economy to stabilize.

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Q3-FY19 Projections: A soft landing is no longer possible

(February 13, 2019)

While the currency remains stable since end November 2018, uncertainty builds about the country’s macro-economic outlook.  This makes it is very difficult to make predictions about the PKR/$ parity, inflation and interest rates.  Hence, we have proposed three scenarios that are contingent on how much leeway SBP has to manage the currency. 

Before discussing these scenarios, we highlight several factors that make us less optimistic: (1) FX repayments have reached unprecedented levels; (2) the external deficit remains stubbornly high; (3) soft oil prices will not be enough to narrow the current account deficit; and (4) fiscal pressures mean the twin deficit in FY19 will remain problematic. 

In the first scenario, SBP continues to manage the currency to eliminate volatility.  While a weaker currency is necessary to narrow the trade deficit, we argue that sentiments in the FX market will not change much, which means Pakistan will struggle with a weak BoP in FY19 and FY20.  In the second scenario, we assume a degree of currency volatility as SBP is restrained in its intervention.  The PKR loses more value, while the volatility creates an anti-import bias.  This narrows the trade deficit to the point where the PKR actually starts appreciating by September 2019.  In this scenario, FX sentiments change and the external sector is rehabilitated in FY20.  In the third scenario, we assume almost no SBP intervention, which generates significant currency volatility and a much sharper increase in interest rates.  This scenario is very disruptive for the fiscal side, and will squeeze out discretionary spending this year and next. 

We argue that Scenario 2 is the better option, despite the currency volatility it entails.  This is based on our view that unless market sentiments change, Pakistan’s BoP gap may not narrow enough to stabilize the external sector.  Borrowing may postpone the eventual adjustment, but this will also perpetuate the current uncertainty and make Pakistan’s FX repayments more unsustainable.  Word Count: 3,437.   

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Could Brexit be a marker of things to come?

(January 25, 2019)

In this paper, we analyze the Brexit issue before the 29 January parliamentary vote.  We structure the paper in three parts: one, the reasons for the utter confusion that currently prevails; two, how the Brexit issue could play out; and three, if Britain stumbles into a no-deal Brexit, what this would look like. 

In the first part, we list five factors: (1) Theresa May’s four red lines that she claims are non-negotiable; (2) how sentiments to leave the EU transcend the Euro-skepticism which has existes in Britain for some time; (3) how the Irish backstop is required to keep a soft border in Ireland, but this clause could pull Britain back into the EU against its will; (4) whether Scotland opts for independence if Britain crashes out of the EU; and (5) how May’s mismanagement of the Brexit issue has left the nation hopelessly divided.  In simple terms, the issue of Brexit cuts across party lines, which makes it very difficult to achieve a political solution. 

In our model we list all possible outcomes after the parliamentary vote.  We explain how a soft Brexit – a Norway Plus option – has a 24% probability of being realized, while a bitter political impasse could result in snap elections (chances are 35%) – this means a no-deal Brexit is more likely with a probability of 41%.  However, we argue that given the acute economic dislocation that will be experienced on both sides of the English Channel, we assume that the 29 March deadline will be extended to achieve a negotiated Brexit.  This refers to a trade deal that will protect small businesses and ensure the smooth supply of basic food products.  While many are of the view that a second referendum will give a vote to remain in the EU, we think growing concern about immigration and a tribal mindset, could unleash a wave of nationalism in Britain.  We argue that in view of growing nationalism in Europe, there may be little reason for Britain to stay within a union that is increasingly unsustainable.  Word Count: 4,526. 

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Pakistan's economic flux is not business-as-usual

(January 07, 2019)

On 26 December 2018, the Pakistan Investment Bond (PIB) was resurrected.  The authorities finally decided to accept more expensive money, borrowing 3, 5 and 10-year money at rates that reflect the 50% increase in the discount rate during 1H-FY19.  With inflation much lower than market expectations, this hike is driven by the urgent need to shift Pakistan’s market debt into longer-term maturities.  We also argue that the government is using soft oil prices to reduce retail fuel prices, to dampen food and transportation costs, and keep a cap on headline inflation.  If inflation in FY19 settles at a lower level than previously anticipated, and banks shift into longer-term PIBs, we think the monetary tightening phase may be almost over. 

With a mini-budget expected in mid-January, we propose that several key uncertainties be addressed.  First, we discuss the need to confirm the start date of the IMF program to provide some confidence to the market.  We also argue that new revenue measures should focus on those who do not pay taxes, which means the government must maintain pressure on non-filers.  As a matter of housekeeping, we suggest that the government should clarify how Pakistanis with overseas assets could regularize their wealth, and reaffirm its commitment to continue the anti-corruption and anti-encroachment policies despite the economic dislocation.  We argue that accountability and documentation are key economic goals the government should stand by.  However, these policies do not give the economy much direction: to address this, we suggest that the PTI government should announce an economic vision that builds on manufacturing, upgrading our labor force, and using CPEC to anchor Pakistan’s development agenda.  Word Count: 3,649.  

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Summary of 2018

(December 27, 2018)

In this paper, we summarize the main developments of 2018.  The narrative shows the mounting pressure on the external sector, and hesitant policy steps to rectify the problem.  While the new government’s tenure has seen significant changes in the PKR and interest rates, there is no clear signal as to when Pakistan will enter the IMF program.  This failure to calm the markets resulted in a bearish end to the year. 

However, we take heart from the on-going accountability drive, as this dovetails into the economic stabilization program.  We argue that the government may use its January mini-budget to change the tone on what it seeks to achieve in 2019.  As the country gears up for the IMF program, the government should reiterate its commitment to accountability and documentation, and announce other policy measures that will support this strategy.  This policy focus will increase the chances of a successful program.  While economic growth will surely suffer, the government should take advantage of this commercial lull to push against capital flight; create a digital record of individual asset holdings; move towards more accurate valuation of real estate; and create revenue measures that capture new payers.  We conclude by saying that global changes in 2019 are likely to be far more unsettling, compared to the short-term pain that Pakistan is likely to experience next year.  Word Count: 5,597.  

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Q2-FY19 Macro Projections: The near impossible balancing act

(December 03, 2018)

We delayed this piece hoping for more details on the forthcoming IMF program.  After the shock PKR adjustment on November 30, we decided to go ahead as we don’t expect program details till mid-to-late January 2019.  Letting the exchange rate go on the day of the monetary policy decision, and the larger than expected increase in interest rates (150 bps), has convinced the market that November 30 is a prelude to the next program.  We look at Egypt’s experience with the IMF in 2016 to show that the initial stages of stabilization can be very disruptive, but argue that Pakistan’s experience should not be as painful. 

In terms of the next program, we highlight the targets on SBP’s net international reserve (NIR), which could put further pressure on the PKR/$ parity.  However, we think that most of the heavy lifting has already been done.  We had anticipated a parity of 140-141/$ by end-June, but the November 30 event has pushed up our projections to 145-146/$ by end FY19.  Compared to our previous projections, this means higher inflation, more monetary tightening, a larger fiscal deficit and lower growth.  While this will dampen economic sentiments, if the stabilization is properly managed, GoP should be able to move on more meaningful structural reforms.  If the stabilization is disruptive, tough reforms will be postponed (again).  Word Count: 4,542.

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IMF negotiations with a Twist

(November 09, 2018)

As Pakistan negotiates its 13th IMF program since 1988, the market’s response has been mixed.  Assistance from Saudi Arabia has shored up the PSX, but the market has been disappointed by the Chinese offer to discuss Pakistan’s economic needs.  We argue that China’s response reveals that it is looking out for its substantial CPEC investment, but this is also the correct path forward for Pakistan.  To make CPEC financially viable, China will want to ensure that Pakistan’s macro economy is structurally strengthened.  This IMF-plus package should dispel the view that CPEC is self-serving, and push our policymakers to implement hard reforms. 

In September 2017, we had suggested that the best outcome for CPEC would be a scenario whereby China helps build Pakistan’s repayment capacity, in conjunction with a strictly implemented IMF program.  In our view, this is playing out.  However, it is important not to view the IMF’s concerns about CPEC as a geopolitical strategy to undermine our economic relationship with China.  We argue that China would encourage Pakistan to undertake hard reforms, and Chinese assistance would be a combination of rescheduled loan repayments and structural changes to narrow Pakistan’s bilateral trade deficit.  We repeat five areas of policy focus, and urge the government to adopt an unorthodox strategy to achieve results. Word Count: 2,488.

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Khashoggi’s murder is a point of no return

(November 01, 2018)

The premeditated murder of Jamal Khashoggi has split the Middle East.  Turkey is pushing to undermine the House of Saud, sensing that this will weaken US policy in the Middle East and isolate Israel.  These forces could change regional dynamics in favor of Iran.  Given the stakes in the Turkey-Saudi standoff, this issue will not go away till the Saudi crown prince (MBS) is removed.  If this happens, the kingdom’s foreign policy will become less aggressive, which may put an end to the war in Yemen and tone down the anti-Iran rhetoric.  In our view, as Turkey and Iran are in the same coalition in the new global order, Turkey may use this momentum to bring Iran back into the fold of the global community. 

This standoff should be viewed in context of the current situation in the Middle East.  Yemen, Libya, Iraq and Afghanistan are already unstable; if the kingdom falters, this will impact the rest of the Middle East.  This regional instability worries the US establishment, which may take charge of US policy towards Saudi Arabia – President Trump may also lose interest closer to his reelection campaign in 2020.  We end by saying that the uncertainty in the Arab world will not adversely impact Pakistan – despite the $ 6 bln aid package from the kingdom, we do not expect Pakistan to take sides.  Word Count: 4,430.

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The Last IMF Program?

(October 18, 2018)

After a hesitant start and some missteps, PTI’s economic team took two meaningful steps in mid-September 2018.  It announced a progressive increase in gas tariffs, and presented a mini-budget to reverse the previous government’s short-lived tax cuts before the July elections.  Since then, the government has conceded that it will be approaching the IMF for a bailout; increased interest rates by more than the market expected; and allowed the PKR/$ parity to depreciate to 133.7/$. 

Clearly the country has a hard year ahead.  Many are skeptical that much will change in the next IMF program.  However, we believe the PTI’s political mandate and the publication of a list of Pakistanis who own properties overseas, suggest that the government will pursue an anti-corruption drive.  We suggest that this disruptive process be embraced with a political strategy to overcome the economic dislocation.  Using the chronic circular debt problem, we remind readers just how difficult structural reforms are.  We then suggest four additional goal-driven endeavors: (1) documentation and revenue generation; (2) external sector sustainability; (3) the need for an industrial policy; and (4) regulatory and institutional strengthening.  Unlike past reform efforts, we propose a reform oversight mechanism headed by Czars, who spearhead each of these areas and keep the country abreast of progress.  We conclude that reforms of this nature cannot be conducted in a business-as-usual manner.  If the government pursues these reforms with political commitment and generates public support for such changes, the next IMF program could be Pakistan’s last.  Word: 6,074.

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Deceptive choices

(September 04, 2018)

Although the political landscape has settled, the economic picture remains confusing.  Media coverage shows that the government has yet to decide whether to approach the IMF.  We suggest there is further confusion: will the government focus on economic relief or macro stabilization?  Will the government impose hard reforms or seek a consensus?  With a record high external deficit in July 2018, the decision to cut retail fuel prices on 1 September, was perhaps not the right signal.  Furthermore, a parliamentary debate about whether Pakistan should approach the IMF is ill-advised, as the newly elected parliament would not want to lose policy sovereignty.  Finally, debating the direction of economic reforms with Pakistan’s status quo, is a non-starter.

These deceptive choices are not addressing the deteriorating balance of payments (BoP) position.  We argue that Pakistan needs both the IMF and assistance from China; it needs to signal that stabilization is more important than temporary relief; and PTI needs to follow its campaign promise of change, and not settle for negotiated reforms.  Bold policy steps are likely to be positively received and will set the right tone for the new government.  With a monthly reminder of Pakistan’s vulnerability coming from SBP (BoP data), the current macroeconomic calm cannot be taken for granted, especially against the backdrop of jitters in Emerging Market countries.  Word Count: 3,754.

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The Challenges Facing Pakistan’s Economy

(August 15, 2018)

This comprehensive paper was commissioned by the Asian Development Bank, Islamabad.  We argue that the various macro challenges facing Pakistan can be traced largely to short-term policymaking and weak state institutions.  In terms of a solution, we argue that returning to the IMF would have to be supplemented with more customized steps to: (1) accurately document all real estate holdings in the country; (2) make the Amnesty Scheme more effective; and (3) talk with our Chinese partners to rethink the focus of CPEC and narrow our bilateral trade deficit via the China-Pakistan FTA.

In a series of standalone boxes, we talk about: (1) poor policy oversight because of a politicized bureaucracy; (2) the need to pursue accountability even if it temporarily disrupts the economy; (3) how CPEC could play out; and (4) how it is in Pakistan’s interest to adopt FATF guidelines, not just to get off their grey list, but to better manage the Rupee.

With on-going developments, we discuss PTI’s election victory, and the US government’s effort to politicize the IMF and CPEC.  We propose possible first steps for the new government, with a specific emphasis on working with both China and the IMF to stabilize the country’s economic outlook.  We dismiss the likelihood that US pressure could make the IMF unapproachable.  We conclude that it is too early to decide whether the PTI government is willing to implement disruptive reforms to cleanse out the system, or settle for a gradualist approach that may not deliver results.  Word Count: 14,710.

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Q1-FY19 Macro Projections: The Challenges Facing Pakistan’s Economy

(August 15, 2018)

This comprehensive paper was commissioned by the Asian Development Bank, Islamabad.  We argue that the various macro challenges facing Pakistan can be traced largely to short-term policymaking and weak state institutions.  In terms of a solution, we argue that returning to the IMF would have to be supplemented with more customized steps to: (1) accurately document all real estate holdings in the country; (2) make the Amnesty Scheme more effective; and (3) talk with our Chinese partners to rethink the focus of CPEC and narrow our bilateral trade deficit via the China-Pakistan FTA.

In a series of standalone boxes, we talk about: (1) poor policy oversight because of a politicized bureaucracy; (2) the need to pursue accountability even if it temporarily disrupts the economy; (3) how CPEC could play out; and (4) how it is in Pakistan’s interest to adopt FATF guidelines, not just to get off their grey list, but to better manage the Rupee.

With on-going developments, we discuss PTI’s election victory, and the US government’s effort to politicize the IMF and CPEC.  We propose possible first steps for the new government, with a specific emphasis on working with both China and the IMF to stabilize the country’s economic outlook.  We dismiss the likelihood that US pressure could make the IMF unapproachable.  We conclude that it is too early to decide whether the PTI government is willing to implement disruptive reforms to cleanse out the system, or settle for a gradualist approach that may not deliver results.  Word Count: 14,710.

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FY19 starts with a bang

(July 16, 2018)

We are surprised by the magnitude of the 100 bps increase in interest rates, and sudden weakening of the Rupee in mid-July.  Our earlier projections were more conservative as they were based on the worrying dynamics of Pakistan’s twin deficits.  While we expected the caretaker government to make necessary adjustments, the manner in which it was done, suggests possible prior understanding with the IMF and aspiring political parties.  The path that has been taken, also means the next government will not have much of a honeymoon period.  Despite the promise of a fresh government two weeks from now, the confusion about the country’s economic outlook remains.  Word Count: 1,296.

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Why global media could have it wrong again

(June 19, 2018)

CNN’s reaction to the Trump-Kim summit in Singapore (June 12, 2018) is surprising.  It took little comfort from the averted threat of a nuclear exchange between the US and North Korea.  Instead, CNN was shocked that a US President was so civil with a dictator who is notorious for human rights violation.  More generally, global media outlets were dismissive of President Trump’s claim that this summit was a success.

In our view, these media outlets will become more belligerent closer to the US mid-term elections.  As they step up their criticism of Trump’s divisive policies, he is likely to respond by playing hardball.  What global media is missing, is that Trump’s uncompromising stance on immigration, and his combative stance with trade partners, play to his blue collar base and fuel tribal thinking.  We believe the showdown in November 2018 will only be about Trump and his policies, not about individual candidates or issues.  This will force aspiring Republicans to either embrace Trump’s divisive world view, or risk losing.  If Trump succeeds and the Republicans retain their majority in Congress, his second term will be more likely.  Word Count: 2,317.

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Reality Bites

(June 06, 2018)

The government has abruptly shifted gears since the caretakers took charge.  Just weeks before, the Ministry of Finance was insisting that the Rupee was not overvalued, only allowing for an adjustment during the IMF’s PPM discussions in December 2017.  It also denied the need for an IMF program.  The government has now accepted reality: the external deficit is much too large, the Rupee needs to weaken, the fiscal deficit will exceed budget targets, and there is some urgency to begin talks with the IMF.

The question is: why did key institutions tasked with protecting Pakistan’s economy, fail to take corrective policy decisions?  Despite a worsening economic outlook, these institutions remained passive – EAD did not sound an alarm (despite debt repayments piling up), and SBP kept the PKR-Dollar parity fixed (despite plunging FX reserves).  In our view, this inaction is as troubling as the economic crisis itself; Pakistan’s bureaucracy can no longer counsel its political masters.  It is therefore complicit in decisions that structurally weaken the economy.

The best the caretaker government can do, is to disclose the true state of the economy, and suggest a credible economic roadmap.  Unlike past reform programs, institutional strengthening must be a priority.  Word Count: 2,312.

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The vicious twin deficits, Part 2

(May 30, 2018)

In this paper we argue that orthodox demand management may not be sufficient to right the economy – an IMF program plus out-of-the-box solutions are now necessary.  Pakistan’s economy faces three major challenges: large current account and fiscal deficits, and a heavy external debt burden.  Efforts to manage these challenges through PKR and fuel price adjustments (and by increasing interest rates), could further stoke inflation.  This means higher interest rates and heavier debt servicing.

As in past IMF programs, if this situation is compounded by the need to reduce central bank financing to the government, the upward pressure on interest rates could become unsustainable for the fiscal side.  This, in turn, could dampen the political will to continue, which may slide into an incomplete program.

To guard against a potential fiscal blowup, PKR revenues must be increased sharply.  While the IMF is likely to focus on increasing the tax base (as it has done in the past), we think it is time for more customized fiscal reforms.  In our view, the country needs to enforce more accurate valuation of real estate holdings, and offer a “fair” amnesty scheme (for resident and non-resident Pakistanis) to draw in more people into proper financial documentation.

For the external sector, hard steps are needed to sharply narrow the current account deficit.  From a longer-term perspective, we suggest reformulating the China-Pakistan FTA to make it more balanced.  As Pakistan’s economic linkages with China grow, there is a need to ensure that the relationship is sustainable.  In effect, Pakistan’s Achilles heel (the external sector) should be fortified by CPEC, not exploited by it.  Word Count: 3,170.

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Trump scuttles the Iran nuclear deal (& the Middle East)

(May 14, 2018)

In this paper we discuss Trump’s unilateral decision to scuttle the Iran nuclear deal.  He now seeks to expand the coverage of the deal to include Iran’s ballistic missile program, and Iran’s regional presence that is deemed to be destabilizing.  We argue that the US does not expect Iran to capitulate but rather to create an environment wherein both parties cannot back down.  By threatening isolation, the US is attempting to break the will of the Iranian people and effect regime change.  It also hopes to push Iran to resume its nuclear program, which would reduce support (for Iran) from other members of the JCPOA.  However, Iran is unlikely to play by the US playbook – it will look to China and Russia for support, and expose the vulnerability of European allies to US sanctions.  This will create the need for a global trade regime that is independent of US influence.

Israel and Saudi Arabia are jubilant (they have been rooting for Iran’s isolation).  However, Iran has shown that it can withstand economic isolation while continuing to expand its regional influence.  Now the stakes are much higher with Iraq, Syria, Yemen and Lebanon already in play, while countries like Bahrain, Saudi Arabia and the UAE could also be targeted.  This could become a tipping point for the entire Middle East region.  Although Pakistan is vulnerable because of inward remittances from the GCC, it should remain neutral in the Iran-Saudi standoff.  Word Count: 3,174.

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Q4-FY18 Macro Projections: The vicious twin deficits, Part 1

(April 26, 2018)

In this paper we argue that Pakistan’s external sector poses a difficult choice for policymakers: either devalue the currency to narrow the CA deficit (which will increase debt servicing and inflation); or continue to plug this gap by borrowing (increase the country’s debt stock that makes future devaluation more painful).

In essence, Pakistan is now trapped in self-enforcing twin deficits.  Despite growing exports and firm remittances, we expect the external deficit to reach $15.3 billion for FY18.  We see the caretaker government devaluing the PKR and raising fuel prices in June 2018, to set the stage for an IMF programme in FY19.  While average inflation in FY18 will be around 3.8%, FY19 will see a return to a higher inflation trajectory.  With the average maturity of T-bills almost down to 3 months, a large increase in interest rates (coupled with PKR devaluation) would exert serious fiscal pressure after 3 months.  We therefore expect the caretaker government to be cautious and raise interest rates by, at most, 50 bps to signal future direction – it will look to the next government to set interest rates as a prelude to the next stabilization program.  In the conclusion, we raise the possibility of a staggered Amnesty Scheme and a rewritten Pakistan-China FTA as unorthodox, but necessary policy responses to Pakistan’s structural BOP problem.  Word Count: 3,209.

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The end of Globalization

(April 18, 2018)

In this paper we argue that the current US-China trade relationship is unsustainable.  We contend that economic arguments alone would likely be insufficient to roll back US consumption of China’s exports.  However, a changing geopolitical stage may provide the political impetus to push through an adjustment to a more balanced trade relationship.

One of Trump’s core promises is a reversal of the free trade paradigm that is blamed (by his political base) for ravaging US manufacturing.  This has prompted Trump’s recent stoking of a potential trade war with China, which incidentally supports Xi Jinping’s need to reduce China’s dependence on exports and infrastructure development.  Trump’s stated position makes China’s transition to a more consumption-based economy politically feasible.  As the US cedes its role as the champion of globalization, multilaterals will look to China to fill the vacuum; however, China’s preference for bilateral negotiation (as seen in OBOR) makes this unlikely.  Moreover, the emerging bipolar world order, will require lower trade dependence to allow a freer pursuit of regional interests.

In the appendix, we discuss a peace agreement between the two Koreas (orchestrated by China), which will involve North Korean disarmament in return for a withdrawal of US troops from the Korean peninsula.  Word Count: 4,610.

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The IMF Strikes Back

(March 23, 2018)

We analyze the IMF’s Post-Program Monitoring Staff report.  While much of it consists of the Fund’s usual observations rendered in IMF-speak, there are several surprising views and admissions – along with a clear suggestion that Pakistan will enter a stabilization program in FY19.

The IMF discusses CPEC in neutral-to-positive terms, in a less alarmist tone than in the past (previous reports focused more squarely on its associated risks – primarily the debt burden imposed).  However, it does address the ballooning external debt, and its discussion of Pakistan’s “capacity to repay” the Fund is essentially a signal of an upcoming stabilization program.  The IMF accepts that the EFF was “incomplete”, and pointedly draws attention to the suspect amendment of the debt limitation act.  The Fund makes passing mention of a “fiscal cadaster”, an obscure term for a database of real estate holdings in a country.  Since real estate is the true driver of domestic demand in Pakistan, such a database would provide policymakers the proper reins to Pakistan’s economy.  We conclude that the IMF puts forward a more realistic narrative about the economy, compared to what was peddled during the previous government.  While the report’s familiarity is not heartening, there are enough moments of candor and clarity, to create some hope about the next program.  Word Count: 3,838.

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Trump’s Tariffs are part of the Show

(March 15, 2018)

In this paper, we argue that Trump’s tariffs on steel and aluminum, while counter-intuitive, make sense given his particular ambitions as President.  It is true that these tariffs may stoke inflation; speed up interest rate hikes; lead to net job losses in the US; spark bilateral trade wars; and undermine the rule-based global trade regime.  Yet the tariffs are exactly what Trump’s base responds to – a broad, symbolic swipe at the rich, globalist elite.  It is the kind of disruptive action that excites his supporters, and is perhaps overdue because of the lack of progress of Trump’s economic agenda.

But there is another pragmatic motive for these tariffs: Trump is likely to use them as bargaining chips in bilateral trade negotiations.  This would directly weaken rule-based global trade and the WTO.  Broadly speaking, Trump’s actions should be viewed through the prism of reality TV: controversy is stirred; conflict is stoked; and viewers are kept guessing.  Fundamentally, Trump is not working for the good of the US or its people, but rather for his own political survival.  Word Count: 2,389.

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FATF and Pakistan’s economic outlook

(February 19, 2018)

We discuss Pakistan’s imminent inclusion in the FATF watch-list.  We argue that while placement on the list does not result in economic sanctions or a reduced capacity to borrow, it may become an instrument in the Trump administration’s attempt to squeeze Pakistan.  If the country is placed on the list and the US is unwilling to compromise, stakeholders could fear the worst – greater scrutiny of banking transactions, reduced appetite for Pakistani bonds, and pressure on the kerb market.  With Pakistan’s precarious BOP situation, SBP could step up import controls and devalue the currency.  If the US-Pakistan stand-off escalates, Pakistan may call the IMF’s credibility into question.  This could become a rallying point for other countries frustrated with US influence over the global financial system.  However, we believe the likely outcome will be an IMF program in H1-FY19, as the Pakistani market is now conditioned to expect the IMF to stabilize the external sector.  We conclude by reiterating that the long-term sustainability of Pakistan’s external sector will remain out of reach as long as aggregate demand is driven by undocumented real estate and the informal economy.  Word Count: 1,807.

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Could a clash with the US Fed endanger Trump’s presidency?

(February 08, 2018)

We focus on rising wage pressures in the US economy that led to a recent correction in the stock market, and how this could create a conflict between the country’s fiscal and monetary policies.  The Trump administration is implementing an expansionary fiscal policy (the tax cut, the pending infrastructure program) just when the Federal Reserve is planning to raise interest rates due to concerns about overheating.  As national debt increases, rising interest rates will exacerbate US debt dynamics, which will add to fiscal deficits.  Given Trump’s willingness to feud with US institutions, the Fed may become his next target.  However, the central bank isn’t just any other institution: open conflict between the executive branch and the Fed may have adverse consequences for the markets.  Word Count: 1,841.

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The Unexpected Interest Rate Hike

(January 30, 2018)

We discuss SBP’s surprise decision to raise the policy rate by 25 bps, citing inflationary pressures.  We argue that while a hike of this magnitude will do little to suppress demand, it allows the SBP to preempt resistance to its economic aims for 2018 (namely, tightening liquidity and raising interest rates).  It has taken this decision to create expectations of further rate hikes.  If these do not materialize, banks will only provide short-term financing to the government.  Therefore, to avoid a worsening of the maturity profile of Pakistan’s domestic debt, policymakers will have to accept the need to increase interest rates, regardless of upcoming elections and other political considerations.  Higher interest rates, along with a depreciated rupee, will also facilitate the country’s entry into an IMF program.  Word Count: 1,810.

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Q3-FY18 Macro Projections: Stepping into the Unknown

(January 22, 2018)

Our projections suggest that FY18 will be a transitional year for Pakistan.  Urgent policy action is required on the external front, namely the staggered depreciation of the Rupee.  This will return the country to a higher inflation trajectory, which will require further tightening of monetary policy.

We expect an IMF program in FY19.  We see the external deficit being higher this year compared to FY17, but not excessively so.  Our projections suggest that higher fuel prices and a weaker Rupee will cause inflation to peak at 8.6% in FY19, before stabilizing in the 7-8% range.  We view this return to price pressures as a reversal of the abnormally low inflation we have seen over the past two and a half years.  With average inflation projected at 4.9% this year, and fiscal management under pressure, we do not see much interest rate pressure in FY18.  Instead, we predict a 100-125 bps adjustment in FY19.

So, while the loss of macro stability will create uncertainty and require careful management, this transition was long overdue.  The artificial economic calm will be disrupted as structural issues demand substantive policy actions.  Word Count: 5,539

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Could the next IMF Program be decisive?

(December 12, 2017)

In this paper, we argue that an IMF program in 2018 is inevitable, as SBP’s unencumbered reserves reach negative $1.8 billion.  We discuss the December devaluation of the rupee, which coincided with the IMF’s post-program monitoring (PPM) discussions.  We contend that the program will focus on making CPEC liabilities transparent and payable, either by scaling back projects or delaying repayments.  The program will likely also focus on implementing more accurate real estate valuations, which will allow policymakers to account for the true wealth in the country.  This is necessary to manage the spending patterns of Pakistanis, especially on imported luxury goods.  We conclude that a confluence of geopolitics and domestic economic compulsions, may be setting the stage for an IMF program that brings real change.  Word Count: 3,334.

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The Saudi Gamble

(November 16, 2017)

We argue that the shocking arrest of several high profile Saudi princes and ministers, is a decisive moment in Crown Prince MBS’s reform campaign.  We contend that the event is best understood within the context of changing regional dynamics, and MBS’s checkered track record (e.g. the Yemen war).

Iran’s growing regional influence and Russia’s military involvement in Syria (not to mention the rift between Turkey and the US), has created a divide in the Middle East.  Saudi Arabia and the UAE have stepped up their anti-Iran rhetoric.  This muscular foreign policy is encouraged by President Trump, who is keen to achieve an outcome that suits Israel and isolates Iran.  We argue that MBS may have opened up too many fronts, which could have unsettling repercussions for the entire Gulf region.  We also believe that MBS’s urgency to sell part of ARAMCO, is part of an all-or-nothing strategy, which is very un-Saudi.  Since Pakistan has wisely decided to stay neutral in this Saudi-Iran stand-off, we fear that worker remittances from the Kingdom and the UAE could fall in 2018.  This will put further pressure on Pakistan.  Word Count: 4,449.

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Too Little, Too Late?

(October 18, 2017)

In this paper, we discuss the government’s newest “clever” policy step – the imposition of import duties on a host of consumer items.  We argue that a closer look at the list reveals that many of these imports are insignificant in value.  In fact, closely related items that are imported in substantial amounts, are left off the list.  We contend that, in the past few years, Pakistan’s economy has been coasting along because of the fall in oil prices and the initiation of CPEC.  The resulting increase in private wealth has fueled unproductive imports, which were easy to finance.  As SBP’s FX reserves started falling, the policy response was to increase borrowing to fund the external deficit.  This was coupled with a refusal to let the Rupee adjust for fear of increasing inflation and interest rates.  We conclude that this short-termism has deposited us (once again) at the doorstep of the IMF, making a stabilization program inevitable in 2018.  Word Count: 1,709.

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A Self-Induced Challenge to the US Dollar

(October 13, 2017)

We explain the dominance of the US Dollar over global trade, by likening international trade to a physical marketplace owned by the US, and used by all other countries.  The perennial demand for the dollar allows the US to run large external deficits (while the rest of the world runs a net external surplus).  Furthermore, its ability to unilaterally impede dollar transactions (by halting dollar clearing) allows the US to inflict economic pain on its adversaries.

We argue that global trade and macro imbalances cannot persist indefinitely.  China is planning RMB-denominated futures to transact with oil exporters in RMB rather than the dollar, which would reduce demand for the dollar.  We contend that Iran could be the first to opt for the RMB oil future, and as the instrument gains acceptance, the dollar will weaken while the RMB will strengthen.  This should cause US imports to fall as China’s imports from the US rise.  The rebalancing is required to make global trade more sustainable.  Word Count: 4,694.

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Geo-political Developments

(October 02, 2017)

We argue that the media coverage of the US-North Korea stand-off, dulls the true urgency of the issue.  A closer look reveals that a nuclear exchange is a distinct possibility, given the leadership of these two countries.  We use a probability distribution framework to analyze potential outcomes.  We conclude that, surprisingly, the least destructive path forward will involve a successful ICBM launch by North Korea.  Word Count: 2,972.

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Pakistan’s Balance of Payments, the IMF and China

(September 14, 2017)

We present three BOP scenarios for FY18, and argue that the likeliest scenario will involve an FX crisis resulting in an abrupt devaluation in Q3-FY18.  We then discuss potential directions the Pakistan-China relationship might take in light of the build-up of CPEC-related debt.  If China treats CPEC as a commercial venture, there could be two outcomes: (1) China helps enhance Pakistan’s FX generation capacity (by investing in the export sector); or (2) it acquires Pakistani assets when the country is unable to repay its FX debt.  We conclude that the latter would sour relations and breed resentment in Pakistan, which will undermine CPEC’s long-term prospects.  The likely way forward will involve joint ventures between the two countries that enhance Pakistan’s export earnings.  Word Count: 4,252.

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The Qatar Blockade could have geopolitical repercussions

(June 08, 2017)

In this paper (published 3 days after the blockade was imposed) we predict that Qatar would not accede to Saudi demands.  It would instead weather the diplomatic crisis and economic isolation.  We argue that the blockade pushes Qatar closer to Iran and Turkey, reinforcing the presence of an anti-Saudi bloc in the region.  We conclude that, while Qatar will have to withstand some economic pain, its massive natural gas reserves (that it shares with Iran) and associated long-term sales agreements, give it an edge in the stand-off.  Word Count: 3,410.

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Pakistan’s BOP: The Calm before the Storm

(May 31, 2017)

We argue that the brewing BOP problem is distinct from previous external sector crises – it is not driven by an oil shock, but structurally weak export revenues and a bleak outlook for remittances.  We discuss possible measures to relieve short-term pressure.  We then argue that CPEC will fail in the long term unless Pakistan’s capacity to generate FX is revived.  Finally, we contend that given Pakistan’s weak institutions and shrinking export sector, China may have to be more proactive by initiating export ventures within the country.  Word Count: 6,148.

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The Changing Global Order

(May 10, 2017)

We argue that events such as Brexit and the election of Donald Trump are a prelude to a changing global order.  We contend that current US dominance will give way to a bi-polar world with two alliances: the US Allies (India, Saudi Arabia, Israel and the UK), and the Sino-Russian Axis (with Iran, Turkey and Pakistan).  These blocs are remarkably well-balanced in terms of population, nuclear weapons, economic resources and growth outlook.  We discuss Syria and North Korea, two current flashpoints, in some detail.  Word Count: 2,907.

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Does Pakistan need an Industrial Policy?

(January 05, 2017)

We argue that a break from the Washington Consensus and a return to development finance institutions (DFIs) may be good for Pakistan.  We use examples from Asia to show that broad-based industrial development (especially within heavy industry) can be achieved through strategic government intervention.  We conclude that CPEC could provide the blue-print for Pakistan’s industrial policy, which is focused on power projects, industrial cities, transport networks and Gwadar Port.  Word Count: 2,227.

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The Parable of Pakistan and the IMF

(December 27, 2016)

We examine Pakistan’s prolonged relationship with the IMF through the parable of a self-serving doctor (the IMF) and the weak-willed patient (Pakistan).  The doctor is unable, or unwilling, to curb the patient’s bad behavior.  We argue, with the aid of a simple game theoretic model, that geopolitical compulsions and bureaucratic inertia create an environment where it is always in the interest of the doctor to string his patient along, without forcing any real, lasting change.  This pattern, which dates back to 1988, may not continue in the new world order.  Word Count: 2,029.

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Cashless in Kolkata

(December 02, 2016)

We argue that media coverage of India’s demonetization has missed the point.  Despite its poor implementation and disruptive impact, demonetization signals India’s willingness to repair and rewrite the Social Contract with its people.  We contend that by documenting its economy and curbing the use of black money, India is changing its economic orientation to book its seat at the big table.  Word Count: 2,003.

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Addressing the real economic challenges facing Pakistan

(November 21, 2016)

We discuss “non-IMF” economic challenges facing Pakistan.  We argue that Pakistan must take decisive economic steps in the spirit of India’s demonetization.  This could be achieved by documenting its increasingly dominant informal economy, ensuring more accurate real estate valuations, and curbing corruption and capital flight.  Word Count: 1,558.

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The Trump Phenomenon

(September 28, 2016)

In this paper (published over a month before the US election) we predict that Trump would create a lasting political movement and permanently transform the Republican Party.  We consider Trump’s rise against the backdrop of American workers disadvantaged by unfettered globalization; the 24-hour news cycle; social media; and the ideological shift to the center by both major US political parties.  We predict that the US will move closer to protectionism, as demands for equity overshadow the pursuit of economic efficiency.  Word Count: 2,348.

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One Belt, One Road: Building Asia on China’s Strengths

(August 12, 2016)

In this paper, we try to address some of the more worrying perceptions about CPEC, by considering China’s impelling economic and geopolitical motivations behind the initiative.  We put this into historical context by summarizing China’s unprecedented success in transforming its own economy (“The Great Leap Forward”) using a heuristic, trial-and-error style of economic reform.  This is anchored to a long-term macro vision while remaining flexible on how to achieve these goals.  We argue that CPEC’s deliberate vagueness becomes much less alarming when one abandons the “Washington Consensus” view of economic reforms.  We conclude with a consideration of possible future developments (vis-à-vis hard and soft power) for the US, UK and China till 2040.  Word Count: 9,526.

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Brexit: Why the 23rd June Referendum is just the beginning

(June 14, 2016)

In this paper (published 9 days before the vote) we predict that the UK would leave the EU.  We argue that the EU’s impact on the Britain’s economy and British culture has created a level of resentment within the British public, which will push England to reclaim its unique national identity.  We contend that Brexit may in fact help restore balance to the British economy, which has developed a lop-sided focus on financial services and high-end retail & real estate.  Word Count: 4,374.

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