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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.

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.   

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. 

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.  

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.  

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.

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.

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.

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.

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.