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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.


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.


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.


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.


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.


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.


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.


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.


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.


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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