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The New Great Game

(September 05, 2020)

Pakistan’s economy is no longer hampered by the pandemic, but an economic recovery is nowhere in sight.  We argue that events outside the country could have a stronger bearing on the economic outlook than domestic politics and policymaking.  Although the external deficit has narrowed sharply in recent years, we think policymakers are being cautious by not signaling a growth phase.  Increasing economic growth will require imports, and the market is still unsure about the country’s BoP position this fiscal year.

The flux in global and regional events add to the uncertainty.  The US heads into a bitter and potentially disruptive election; Iran has recently signed a 25-year strategic alliance with China (and downgraded its relations with India); the UAE has formally recognized Israel; and there have been signs of strained relations between Pakistan and Saudi Arabia.  We build on our 2017 paper that proposed a new bipolar world order, and suggest that recent events in the Middle East could be telltale signs of the new system coming into existence.  Unfortunately, while Pakistan’s long-term interests are with the Sino axis (China, Russia, Iran & Turkey), its economy is largely dependent on US allies (Saudi, UK, Israel, India and the IMF).  This new Great Game in the Middle East region could force Pakistan to choose sides.

Global economic fundamentals will not help.  Remittances from the GCC are likely to fall, and exports could be adversely impacted by the global recession.  As air travel picks up, remittances could fall further and put pressure on the currency.  For an import dependent country like Pakistan, the stability of the rupee and the availability of hard currency are the most important factors that drive commercial activity.  How the foreign exchange issue is resolved depends on how Pakistan’s friends view our foreign policy stance.

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Pakistan’s recovery will be heavily constrained

(August 15, 2020)

With Pakistan’s impressive containment of the pandemic, thoughts are shifting to the economic recovery.  With the government opening larger segments of the economy, people are talking up a V-shaped recovery.  While demand conditions are improving and the government can take credit for how it has managed the pandemic, there are mixed signals: the government is talking up the economic recovery, but key policy parameters tell another story.  More specifically, the weakening rupee (despite a marked improvement in the BoP during FY20) and rising retail fuel prices, are dampening business sentiments and could constrain the recovery.

We argue that Pakistan’s external sector may not allow for much of a recovery.  Pakistan’s economic growth is heavily dependent on imports, and SBP’s FX reserves are not that comfortable.  The paper illustrates the acute level of import dependency in the past decade, and argues that a growth burst is too risky given the heavy dollar repayments in the year ahead.  The pandemic may have spared Pakistan, but the world economy is still struggling and this will surely impact us.  Our primary concern is worker remittances and whether Pakistan can secure new loans for friendly countries in the GCC and China.

Perhaps SBP’s exchange rate management seeks to ensure that improved business sentiments do not push the country back into a BoP problem.  In effect, Pakistan’s economic recovery hinges on the EFF that has yet to be reactivated.  As expectations of an economic recovery gain momentum, policymakers need to remind the country that the outlook remains challenging, and the best way to do this is to push the IMF to restart the EFF and share this outlook with domestic investors.  We end with a more sobering assessment: Pakistan must wean itself off imports, but this will be resisted by Pakistan’s business elite and the IFIs.  Having said this, policymakers need to realize that structural changes are desperately needed in Pakistan’s external sector, and rupee management alone will not deliver the level of import substitution that is now required.

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Covid-19 cases are down, but will this help the economy?

(July 29, 2020)

Pakistan appears to have controlled the pandemic far better than anticipated.  Daily infections have been falling since mid-June, and accounting for the people who recover from Covid-19, the number of currently infected is only 25,513 as of 28th July.  For a country of Pakistan’s size, this is very impressive.  We realize that risks remain – especially with Eid and Moharram in August – but given the success so far, we are confident the government will ensure that health protocols remain in place to ensure there is no second wave.

While Pakistan’s containment of the virus is impressive and people are aware of this, it may not necessarily improve the economic outlook.  Anecdotal evidence suggests that retail volumes are up since the lockdown ended in May, but demand conditions for a broad spectrum of businesses remain weak.  It is important to realize that the monthly pick up in sales (e.g. in cement, autos, iron/steel) is based on the deep slump in May and June, but looking at it on a year-on-year basis, the numbers are distressing.  Furthermore, since a large part of Pakistan’s economy is undocumented, analysts and policymakers do not really have a handle on the level of depressed demand in the economy.  In terms of returning to normal, this is only possible after a certified vaccine has been implemented across the country.  Despite positive news that vaccine trials are at an advanced stage, it is safe to say that Pakistan (and the rest of the world) will not be free of the pandemic till well into 2021.

In the interim period, since Pakistan’s economy is largely undocumented, the policy reach to bailout SMEs (which provide the bulk of urban employment) is severely limited.  We argue that despite the cost of remaining undocumented, businesses will not rush to document their activities, as they do not trust government promises and the tax collection machinery.  The Social Contract that underpins a buoyant fiscal system has been ripped to the point where real change now requires a reset in the entire governance system.

In terms of the immediate outlook, we flag the disconnect between the sharply lower external deficit (especially in the last quarter of FY20) and the weakness of the rupee since early June.  We argue that returning to the EFF and keeping SBP’s FX reserves above a certain level, may be the reasons for keeping the rupee weak.  A better outcome with the pandemic could trigger pressure on the external sector, which may reverse the sharp narrowing of the current account deficit.  Since Pakistan’s BoP for FY20 was only $ 3 bln (against a $ 6.6 bln target), the authorities may want to protect these gains when facing a challenging fiscal front in FY21.  In effect, Pakistan’s recovery will be slow, and the golden opportunity to push documentation is perhaps too challenging for the incumbent government.

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Planning for the future

(July 10, 2020)

Despite the fact that the federal budget for FY21 was released in June, businesses cannot plan for the year ahead.  With Pakistan about to restart the EFF – which was interrupted by the coronavirus – the roadmap for FY21 will be announced when the next IMF Staff Paper is released.  Since this will require data consolidation for FY20, further discussions between GoP and the IMF, time to write up the report, and the IMF’s board approval, this document may not be published till mid-to-late August.  Having said this, Pakistan’s economy has fared well so far, and is well placed to handle the external shocks expected in FY21.

The other piece of good news is that the spread of Covid-19 appears to be coming down.  Since late June, daily infections have been falling, and if this trend continues for the next few weeks, it is safe to say that Pakistan has reached it peak much earlier than anticipated.  The fact that global infections are breaking record highs, should be a source of satisfaction for the country.  However, we argue that the economic fate of individual countries is not tied to how well the specific country has managed the pandemic.  For an interconnected world, we highlight that the impact of the pandemic has been very uneven across the world, which will complicate the path towards recovery.  If the economic recovery in the G7 is delayed (e.g. the US is back in panic mode and Europe is still very cautious), this will hamper the economic prospects in EM and frontier countries.  In our view, demand conditions will remain subdued as long as the virus is viewed as a threat; furthermore, the lack of clarity about the specific pathogen (e.g. the number of strains of coronavirus, the incidence of re-infection, the lingering threat to cognitive capacity, etc.) will continue to dampen sentiments.  Until the virus is fully understood and health protocols are strictly followed, global demand will not allow for a full recovery.

The upshot is that government policies to jumpstart the supply side can only go so far when demand remains cautious.  Until the pandemic is credibly controlled, this status quo could persist right through 2021.

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The short, medium and long-term outlook with Covid-19

(June 26, 2020)

The pace of infections and deaths has accelerated since Eid (24th May), which coincided with the opening up of the economy.  In response, the government has imposed smart lockdowns.  Containing the pandemic should have greater priority over restarting the economy.  The logic is simple: if the pandemic continues to spread, people will stop interacting and the economy will not be able to sustain livelihoods;

The demand destruction is concentrated in non-essentials and luxury goods/services.  We argue that demand revival will be slow and also uneven – again luxury goods will be the last to recover.  Hence, many firms are facing insolvency that could result in structural unemployment.  This will not be a one-off event, but a gradual process.  SBP has launched several schemes to help struggling firms, which all focus on refinancing or liquidity support.  While this may allow firms to better manage their cashflows, if the underlying demand does not pick up, refinancing will not help businesses survive.

The federal budget for FY21 was not credible, but it does signal that the IMF’s stabilization program should restart in July.  Pakistan’s macro economy has held out quite well against the pandemic and is now better placed to handle external shocks.  In our view, the EFF should be viewed as an insurance policy against the pandemic.

Pakistan’s BoP continues to surprise, and posted a $ 13 mln surplus in May 2020.  While the sharp narrowing reflects the acute slowdown in the economy, as a time of global uncertainty, this is a good thing.  Inflation also continues to fall and should be at the lower end of the projected level at the start of FY20.  SBP surprised the market by cutting rates by 100 bps (25th May), which suggests that this is the baseline for FY21 – however, it will do little to increase credit disbursement or revive the economy.

Our main concern is the limited scope of the bailout packages in Pakistan.  This is because SMEs are the main source of urban employment, and most of these firms are undocumented and therefore outside the reach of government policy.  Hence, Pakistan will struggle to recover compared to other countries with more documented economies.

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Covid-19 overshadows the FY21 budget

(June 11, 2020)

This paper was published before the federal budget was announced. 

Media reports suggest that the Government of Pakistan (GoP) will announce a belt-tightening budget for FY21.  This is likely to be criticized by many since most countries are desperately trying to boost their economies.  However, we take comfort from the government’s stance as it indicates that GoP is keen to restart the IMF’s Extended Fund Facility in FY21.  While analysts may be skeptical of the 2.1% growth projection or the Rs 4.95 trn FBR revenue target for next year, we think the value of the budget is not the specific targets but the government’s intent. 

As a time of acute uncertainty because of the global pandemic, Pakistan’s vulnerable FX position requires policy caution and back-up assistance.  We argue that being actively engaged with the IMF is an insurance policy for the country. 

However, the federal budget will not be a useful guide of what to expect next year.  Without credible balance of payment projections for the year ahead, commercial entities will not be able to gauge the business environment in FY21.  We argue that the IMF’s next Staff Paper will better anchor market expectations, which in turn will determine how Pakistan’s economy will fare next year. 

Of greater relevance is the rapid spread of Covid-19 in the country.  If the spread of the pandemic is not brought under control in the immediate future, the looming healthcare crisis could easily undermine the government’s economic goals for next year.  The data on infections and deaths show that the post-Eid easing of the lockdown was premature.  While we acknowledge the government’s view that the lockdown was killing jobs – and could begin to have the same impact on the working poor – the lives-vs-livelihood trade-off is misleading.  If the pandemic continues to spread at an alarming rate, businesses will eventually stop operating, which means the economy’s ability to sustain livelihoods would be jeopardized. 

The policy priority should be to contain the pandemic, and then revive the economy. 

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Update on Covid-19 and some crystal-balling

(May 31, 2020)

This paper is split into two parts.  The first is about the incidence of Covid-19 in Pakistan, and the other is an effort to understand how the world economy is likely to be shaped by the pandemic. 

Official data reveals that infections and deaths are accelerating, while testing has started tapering since mid-March.  European countries and many states in the US have seen a fall in daily infections, which means these countries have experienced a peak.  G-7 governments have started opening up their economies after proof that they are past the peak.  In Pakistan, markets have been opened after Eid, but daily infections and deaths are still trending up.  We argue that unless the people are confident that the pandemic is under control (i.e. after we have passed the peak), the domestic economy will not recover.  With the virus spreading across the country, a much stricter lockdown is now more likely.  We also warn readers to be more cautious now than they were two months ago.  Lockdown-fatigue is understandable, but must be resisted. 

On a global level, we start by arguing that a V-shaped recovery is not likely as conventional policy tools may not change investor behavior.  Political leaders and the market hope for a quick recovery, but if the pandemic is viewed within context of current geopolitical developments, the economic recovery may be a more prolonged U-shaped.  We list six issues that may change the face of the post-pandemic recovery: (1) the growing tension between China and the US; (2) how President Trump may behave in the lead-up to elections; (3) the growing north-south divide in the EU; (4) the new normal for oil and global tourism; (5) possible complications in the development of a vaccine and the immunization phase; and (6) whether the pandemic could mark the end of the globalization era. 

In our view, the Covid-19 pandemic will exacerbate the discontent with globalization.  With leaders like Trump and Bolsonaro disgraced by their mismanagement of the virus, we hope populist politicians will lose traction.  Also, we think the pandemic has strengthened the need to tackle climate change, which bodes well for Green political parties.  However, with dystopian US leadership and a divided Europe, there is no steady hand to shape the post-globalization period. 

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Update on Covid-19

(April 13, 2020)

As the pandemic spreads globally, the impact on Pakistan is clearly being felt on the external sector.  SBP’s reserves are falling sharply as portfolio investment continues to flow out.  Since 25th March, SBP has managed to keep the currency rangebound, but this is contingent on the level of disruption to export receipts and worker remittances.  We argue that remittances could experience a step-down, as the pandemic has suddenly unhinged the GCC’s non-oil economic model.  With travel, tourism and hospitality almost falling off a cliff, and oil prices still soft despite a 10% cut in global supply, the GCC economies will experience a deep recession.  We argue that even if monthly remittances fall by $ 250-300 mln, this will hit Pakistan’s BoP and the rupee parity. 

The government has stated that it must reopen the economy, as the economic costs could be just as fatal as the pandemic.  Till now, the decision to relax the lockdown has not been announced, but we expect a construction-driven push before the month ends.  While this is the best option available, the economic revival will be partial as demand for non-essential goods and services are likely to be a fraction of the pre-pandemic level.  This means job insecurity, job losses and partial pay – the true cost of the pandemic will only be known when people get back to work. 

While the government has announced special loans to SMEs and retail businesses to ensure that employees are paid during this collapse in confidence, we are not convinced this will stop commercial entities from laying off employees.  We argue that the pandemic will hit demand hard, and the government’s efforts to revive supply will do little to increase demand.  The pandemic has created a great deal of uncertainty that impacts people’s sending behavior; this in turn determines consumer demand.  As long as people remain uncertain about the future, demand will remain subdued. 

We therefore argue that the government should focus all its attention on testing people and making this information available to the public.  In our view, more comprehensive information about the pandemic’s spread and those people who have developed an immunity to the virus, will allow private businesses to better plan for the future.  Compared to subsidized or interest-free loans, greater certainty will be more effective in limiting the economic downside. 

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SBP versus MoF (and more)

(April 09, 2020)

A media report about growing tensions between the central bank and the government, is a disturbing development.  This comes from the amended SBP Act, which was sent to the Law Ministry to be tabled for parliamentary discussion.  The latter was an IMF target for end-March. 

The report claims that SBP’s amendments were: to disband the Monetary & Fiscal Policies Coordination Board; eliminate government guaranteed lending by commercial banks; remove the Secretary Finance from SBP’s Board; increase the term of the SBP governor to 5 years, with the possibility of one extension; and effectively curtail the government’s ability to remove the SBP governor before his/her term is done.  While enhancing SBP’s autonomy has been a persistent part of past IMF programs, this is far more ambitious.  As expected, it triggered a strong – but anonymous – pushback from the Ministry of Finance (MoF). 

We argue that increasing SBP’s autonomy is a good thing, but if this is used to narrow the focus of the central bank, it would be unwise.  More specifically, if SBP adopts a single-minded focus on inflation control using inflation targeting, this may create an environment whereby SBP would be operating at cross purposes with the government. 

We are concerned that this standoff could complicate the EFF, and do not expect MoF to be too heavy handed.  In our view, this entire issue is the result of very poor timing.  In the midst of the global pandemic where the government has been scrambling to stay ahead, this demand for greater independence should have been delayed.  As the economic cost of the pandemic becomes clearer in Pakistan, both institutions need to be working together instead of carving out spheres of influence and staying aloof. 

We end with a few takeaways about the pandemic: (1) the longer the lockdown, the more dysfunctional the economy becomes; (2) financially desperate people are more likely to defy the lockdown; and (3) the growing uncertainty will sharply reduce demand for non-essential goods and services.  In effect, the pandemic has posed a very uncomfortable policy tradeoff: the health of the people against the health of the economy.  The only consolation Pakistan has is that this impossible choice is being faced by every country in the world. 

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Rupee comes under pressure and may remain stressed

(April 03, 2020)

Two pieces of economic data captured media headlines: the 220 bps fall in YoY inflation in March, and the unexpected weakness of the rupee on the 25th of March.  The cause for the sudden weakness of the rupee can be traced to the retiring of dollar loans by importers, when the latter realized that the pandemic could add further pressure on the rupee. 

While the economic impact of the pandemic is yet to be quantified, it is clear that the GCC will be severely impacted.  Oil prices have collapsed and so has travel/tourism, which means the abrupt slowdown in economic activity in the GCC, could reduce remittances into Pakistan and keep the rupee under pressure.  With a bleak global outlook for the next several months, we see the currency weakening to 173-174/$ by June 2020. 

SBP’s FX reserves will fall and the outflow of portfolio investment will continue, but social concerns now dominate policymaking.  Since the bulk of non-farm labor works in the undocumented sector, the lockdown is taking a serious toll on daily wagers.  The Prime Minister has stated that Pakistan cannot extend the lockdown indefinitely, and there is no choice but to move towards reopening the economy.  The government has announced special incentives for the construction sector, which specifically targets daily wagers and creates demand for a host of ancillary industries.  In the paper, we suggest a number of steps to ensure that the end of the lockdown is not chaotic nor does it unleash a larger health crisis. 

This pandemic is only about hard choices: more people will be infected and die; businesses will suffer; people will lose jobs/livelihoods; markets will remain volatile; investment will stop; savings will be depleted and wealth will be eroded.  This may remain in play till a vaccine is created, tested, mass produced and administered, which could take up to a year.  Nevertheless, this crisis gives the government an opportunity to prove its worth.  In this period of uncertainty and fear, the government should do things it would otherwise shy away from.  In this period of Covid-19, it should consider implementing disruptive economic reforms. 

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