Business sentiments continue to improve on the back of single-digit inflation, falling interest rates, soft Brent, stable commodity prices, rising FX reserves, and a very stable rupee. PSX rally is unprecedented;
There are concerns the PML-N government may opt for a quick growth strategy even though past economic booms have always ended in a BoP and debt crisis;
We think favorable economic conditions could increase organic growth – i.e., without expansionary policies;
$ 729 mln CA surplus in November is a record for Pakistan. The IMF’s $ 3.6 bln CA deficit target for FY25 needs to be sharply reduced, which also means the $ financing gap in FY25 has disappeared;
Taxes/levies on fuel will likely be delayed till March/April to maintain YoY inflation below 5%. The 200-bps rate cut disappointed the market, and expectations are growing of further rate cuts;
Imports are likely to increase in 2H-FY25, which means SBP must find a suitable balance that delivers more growth and also satisfies the IMF;
The heavy-handed treatment of PTI, the judiciary, and the Western provinces implies that political tensions remain high. PML-N appears powerless and is losing public support;
The sudden collapse of the Assad regime in Syria means that Iran’s Axis of Resistance has been systematically downgraded. This means significant changes are possible in the Middle East region.
The unscheduled IMF mission is not viewed as a negative for the EFF;
GoP has announced that it will not release a mini-budget, and will not impose PDL/GST on fuels till March 2025. This has sharply reduced our inflation projections, with our average inflation projection for FY25 at 7.2% compared to 11.5% last month;
With single-digit YoY inflation projected till April 2025, there is lots of room for further interest rate cuts;
Pakistan’s current account balance is a surplus of $ 218 mln in 4m-FY25. This keeps the rupee stable and FX reserves rising, which underpins the improvement in business sentiments;
If the IMF brings down its CA deficit target of $ 3.6 bln for FY25, the $ 2.5 bln financing gap could be filled without asking for debt rollovers;
There are growing hints of a more credible power sector reform agenda. This is likely to be flushed out in the coming months;
Simmering politics and ongoing terrorism could flare up as the Establishment maintains its uncompromising strategy in the Western provinces;
Trump’s comprehensive election victory has triggered a sense of global dread. We argue that the fears are exaggerated.
EFF begins without prior actions and the immediate release of the 1st tranche;
IMF Staff Paper (SP) emphasizes the need to broaden the tax base, and contains very ambitious FBR revenues for the next three years;
The EFF curtails the powers of SIFC and could undermine the 2nd stage of CPEC;
The Tajir Dost Scheme is off to a poor start, but we expect strict compliance from November;
YoY inflation comes in at 6.9% in September, while the CA shows a surplus of $ 119 mln. The market expects further rate cuts, but the EFF could reverse the inflation trajectory;
SP shows that official sources of FX (IFIs and bilaterals) will taper off and need to be replaced by private capital inflows (from individual investors). This will not be easy;
A watered-down 26th Amendment has been approved, and the government will appoint the next CJP. The legal fraternity and local media are strongly opposed to this amendment. PTI has promised to bring people out into the streets in favor of an independent judiciary and Supreme Court;
Pakistan’s power sector needs a holistic analysis, as the policy of full cost recovery is already failing. Case-by-case cancellation of PPA will not provide much relief and is undermining business confidence.
Nawaz Sharif announces a relief package for power users in Punjab and Islamabad, whereby residential users below 500 units/month will see their tariffs cut by Rs 14/unit for the months of August and September;
This may not have been discussed with Aurangzeb, as it looks to be a breach of GoP’s commitment to the IMF to secure a staff-level agreement (SLA) in July;
In our view, the announced package was in response to the mounting public anger with the elevated power bills in July, with NS taking charge to regain public support. However, the IMF’s final approval to start the EFF by end-August, appears to be delayed, putting into doubt whether the EFF will get the board’s nod;
Fuel price cuts in August have reduced our average inflation projection for FY25 to 13.8%. However, with Iran and Hezbollah likely to strike Israel in retaliation for the assassination of Ismail Haniyeh, oil prices could spike, which will increase our inflation projections for the year;
The rupee parity has remained almost fixed since January 2024. However, with imports rising and the EFF currently stalled, SBP may have to change its exchange rate policy to manage the external sector;
With the exception of May, the $ 3.6 bln non-oil import bill last month was the highest since August 2022, when the fiscal/monetary boost pushed up GDP growth beyond 6%;
A current account deficit in the past 3 months is not alarming, but if imports continue to increase and textile exports fall, the BoP comfort in FY24 will not carry over this fiscal year;
Strong monthly remittances since March 2024 have created the BoP comfort and should remain robust during FY25. But if fresh $ inflows from the IFIs are not in the pipeline, SBP may have to curb import demand to stay current with ongoing debt payments;
The market expects further interest rate cuts on the basis of statements from the government. However, if the EFF remains in limbo, SBP may shy away from further rate cuts till the EFF has started;
Auto imports (CKD) have increased since January 2024 and are likely to increase further with the launch of several high-end EV models in the Pakistan market. Even the high prices of these vehicles have not curbed demand;
Tensions between GoP and the SC remain elevated, prompting some to warn that Pakistan could be heading towards a Constitutional crisis. Furthermore, the court martial proceedings against Gen Faiz Hameed are being seen as an effort to discredit IK, which means the Establishment and PTI remain at loggerheads;
The marked slowdown in internet services across the country has been heavily criticized by local media, IT professionals, and social media users as a pointless effort to clamp down on digital terrorism;
The student protests that overthrew Sheikh Hasina as the PM in Bangladesh after 15 years in power have shocked the world. Yunis (Grameen Bank) has taken charge of an interim setup, and is expected to announce fresh elections within 3 months. Many in Pakistan are hoping for a similar turn of events here;
If the expected Iranian strike against Israel spreads into a regionwide conflict, this will not just spike global oil prices, but it could also deepen the East-West divide. This will be difficult for Pakistan as it tries to balance the interests of the West (via the IMF) with the demands of its bilateral friends.
A staff-level agreement (SLA) is achieved for a 37-month EFF. Board approval and 1st tranche are expected in the coming weeks, but the EFF will impose economic pain on the salaried class and the lower middle class;
As expected, fiscal concessions are provided to PML-N’s support base, with lip service about expanding the tax base;
A generous budget for defense and pay rises for government officials (and tax concessions on real estate transactions for both) has angered the salaried class, and is being expressed via mainstream media;
July’s power tariff/surcharge hikes could result in social disruption across the country;
GoP moves to renegotiate Chinese IPP repayments, perhaps as a first step towards more comprehensive renegotiations with all IPPs. This may be too little too late;
Two fuel hikes in July will stoke YoY inflation, which is projected to increase throughout FY25. Our projected average inflation for FY25 is 16.2%;
The rupee remains below 280/$ for over six months. SBP has also managed its FX reserves very well, making record $ profit/dividend payments in Q4-FY24 while maintaining reserves above $ 9.4 bln;
The booming stock market and stable rupee result in a sharp increase in carry trades and foreign equity inflows. This may ease as the EFF’s austerity kicks in;
Mainstream media is angry about the budget and blames PML-N, while it is equally angry about the political uncertainty and squarely blames the Establishment;
SC recognizes PTI as a legitimate political party and tells ECP to award PTI its reserved seats. This is a blow to PML-N and the Establishment, as PTI becomes the largest party in the Center. The government has threatened to ban PTI for sedition, but PPP has urged caution – the consensus is that the Boys proposed this idea, while it is said that NS is not in favor of banning PTI;
The standoff between PML-N/Establishment and the SC could create a constitutional crisis. Prominent opinion formers have warned that this standoff could result in direct control;
The Labour Party wins a landslide election in the UK, while the National Front in France secures the largest number of seats in parliament. President Biden is almost certain to step down as the Democratic candidate and Trump could win a landslide victory in November. These events will usher in significant changes in the global world order, but it is too early to say how this will impact Pakistan.
The budget announced on 12 June was professionally managed, but the post-budget press conference was tense;
There was no mention of direct taxes on PML-N’s political base (retailers, traders, real estate developers), as the fiscal burden fell on the salaried class and the general public (via GST on milk, medicines, and other essentials);
Budget debates in parliament are not converging, as Treasury MNAs are criticizing their own finance minister. PPP initially refused to attend the budget session, and is still complaining that it was not consulted in the budget-making exercise;
As expected, SBP cut interest rates by 150 bps. The IMF has not reacted yet, after praising SBP’s monetary policy stance in May 2024;
The budget that gets approved (which has to happen next week) is likely to be watered down. The issue is whether the approved budget will secure a nod from the IMF.
Despite the economic uncertainty, the stock market is booming. Furthermore, the rupee parity has not changed much in the past three months;
FX reserve management is still vigilant and should remain above $ 9 bln till end FY24. However, with non-oil imports trending up in FY24, we see a more challenging BoP position in FY25;
May’s YoY inflation fell to 11.8% from 17.3% in April. While the government is celebrating this outcome, we have our reservations. Furthermore, GoP’s estimate that average inflation will be 12% in FY25 does not seem to account for the expected taxes on fuel and energy. Our avg. inflation projection for FY25 is 15.2%, but this is likely to be an underestimate;
With a 40.2% increase in the FBR revenue target in FY25 and nothing concrete on increasing the tax base, we expect a mini-budget after the approved budget if Pakistan seeks to enter the next IMF program. If there is political resistance to a mini-budget, the SLA will be delayed;
As things stand, there is mounting political pressure with the country-wide heatwave, extended load-shedding, and the persistent hikes in power tariffs;
This makes finding common ground with the IMF more challenging. If the BoP position becomes more challenging in FY25, there will be additional pressure on the PML-N government;
In overall terms, the budget has weakened the coalition government, while the Supreme Court is giving verdicts in favor of the jailed PTI leadership. In this complicated political environment, undertaking tough structural reforms will not be easy – if at all possible.
The IMF mission is in Pakistan, but the path forward is unclear. While GoP has been talking about a 3-year EFF, this depends on the FY25 budget and whether it is approved as formulated;
IMF Staff Paper has been released, which reveals its thinking. Its 5-year projections show:
No significant fall in domestic debt servicing in the years ahead;
This means there cannot be a growth-enhancing cut in interest rates;
Commercial banks will continue to be the main source of government financing;
The IMF sees greater dependency on fuel taxes/levies as custom revenues are dependent on the volume of imports;
Imports will have to be financed by export revenues and/or remittances;
And to build SBP’s FX reserves, the CA deficit must be lower than available financing.
The Staff Paper also stresses the need for greater rupee flexibility (weakness), which coupled with taxes/levies on fuel and the regular increases in power tariffs, will keep inflation elevated;
Although the IMF has adopted the GoP’s average inflation projection of 12.7% for FY25, we expect it to increase its inflation projection after the budget is approved. Our average inflation projection for FY25 is 22.3%, which means three years of 20+ inflation. This is unprecedented in Pakistan;
The rupee remains stable at 278/$ supported by BoP flows. Pakistan’s 10-month CA deficit is only $ 202 mln, after posting CA surpluses from February to April 2024. We expect a CA surplus for the full year. However, this BoP comfort does not change the fact that Pakistan’s $ debt is still unsustainable;
SBP disappointed the market by not cutting rates in April, but people are expecting a token cut in June;
Outstanding OMOs hit a record high of Rs 11.8 trn in May, which is 35% of money supply. The IMF will not approve of this quantum of artificial liquidity, but since it appears adamant that real interest rates should be positive, it may turn a blind eye for now;
The Fund mission is focused on the budget as this will anchor the next program. However, if the Budget is watered-down and fails to meet the IMF’s requirements, Pakistan could either get a 1-year SBA or be told to meet its requirements to continue talks for the next program;
This is where Pakistan’s volatile politics could be a hindrance. The Boys are still angry with PTI/IK; NS is challenging the hybrid arrangement; changes in the Center-Province tax formula could split the coalition government; KP is at loggerheads with the Center; the wheat crisis in Punjab shows that even Punjab and the Center are not on the same page; and the unrest in Balochistan could undermine SIFC investment flows;
If the government resists taxing the rich (traders, retailers, developers, landowners, professionals), the IMF could force GoP to pass the burden on to the average Pakistani via utility rates and fuel prices. This will spike inflation and trigger public anger;
The Fund-Bank Spring Meetings went well, with Aurangzeb meeting key stakeholders, think tanks, rating agencies, and media. His focus is clear: the need to expand the tax base; achieve efficiency in the energy sector; and privatization;
The last tranche of the SBA should be released by the end of April. The IMF mission in May will discuss the next program and list the things GoP must deliver to be eligible for another program;
Based on PDL/GST on fuel prices, and elevated Brent prices, we see diesel prices in the range of Rs 311-352/liter in FY25 and a devaluation in the range of 8-10%. This boils down to an average inflation of 23.8% in FY25, which is not much lower than the 25.7% expected this fiscal year;
If true, this would be the third consecutive year of 20% + inflation. Signs of desperation are already visible with the spike in street crime and desperate families pleading for food in affluent neighborhoods of Karachi;
A CA surplus of $ 619 mln in March, brings down the 9-month external deficit to only $ 508 mln. Since we expect this trend to continue in 4Q-FY24, Pakistan may even post a CA surplus in FY24;
SBP’s FX reserves remain remarkably stable at $ 8 bln since the end of December 2023, even after the full repayments of the Eurobond in April. The fact that weekly reserves have not budged much, means SBP had been building a separate war chest to use for lumpy outflows;
With heavy debt payments at the end of FY24, SBP should accelerate its $ purchases and in the process gradually weaken the rupee to avoid sudden adjustments as we have seen in past IMF programs. If the rupee strengthens further or remains stable, import demand could increase as confidence builds;
Expectations of an interest rate cut have fizzled out. We still think a 100-bps cut is needed to ease fiscal pressures and bring down OMOs;
The main policy challenge ahead is inflation. The Punjab government has imposed price controls on Tandoors and poultry sales, triggering protests from retailers. This is an attempt to deflect blame away from the government, but it is unlikely to succeed;
Tensions in the Middle East have eased, but with the ongoing genocide in Gaza, and Israel and Iran opening a direct line of attacking each other, we fear that oil shipments could be impeded. Putin could use this to further tighten the oil market before the US elections to unseat Biden. Pakistan does not have the fiscal space to protect the country from an oil shock;
America’s failed policy towards Gaza could bring Trump to power, which may change the political landscape in Europe.
A coalition government (PDM 2.0) takes charge in the Center, but PPP avoids all ministerial positions;
Muhammed Aurangzeb takes charge as finance minister and will contest for a senate seat as an independent. This has been well received as he is a respected technocrat who is familiar with the IMF team;
2nd SBA review is done and IMF board approval is expected by end-April;
The PM reshuffles the cabinet on 22 March, effectively undermining Aurangzeb’s decision-making powers. Dar is to head a cabinet committee (CC) on privatization, Khwaja Asif will manage PIA’s restructuring, and SS himself will head the ECC and a CC on energy. These areas cover key structural reforms, which will undermine Aurangzeb’s ability to negotiate an EFF with the IMF next month;
SBP maintains interest rates at 22%, but expectations are growing that the next MPC meeting may opt for a rate cut. More than inflation, domestic debt dynamics are alarming as SBP is printing money to finance the government;
The rupee continues to strengthen as Pakistan’s external deficit is much lower than projected. However, with the twin challenge of repaying commercial debt while maintaining a minimum level of FX reserves, SBP should continue buying $s and start weakening the rupee;
The IMF has a hard target on the primary surplus in FY24, which coupled with an absolute freeze on the size of the energy sector circular debts, means GoP faces a tight fiscal situation this year. This may require alternative revenue measures that are easy to collect;
We expect fuel price hikes in May and June, which coupled with utility tariff hikes, will increase YoY inflation in the last quarter of FY24. GoP projects avg inflation in FY25 at 11%, our tentative estimate is 20% +;
February CA posted a surplus of 128 mln, bringing the 8-month total to only $ 999 mln. The BoP challenge is not to contain the monthly deficit, but to purchase enough $s to repay its commercial debt and still maintain a comfortable level of FX reserves;
Pakistan should complete the SBA on schedule, but the required legislation to meet structural benchmarks for the EFF may be difficult for PDM 2.0 – the cabinet reshuffle reveals this;
The political situation remains uncertain. Legal challenges against certain election results and the growing number of terrorist incidents in KP and Balochistan, create headwinds that could undermine the reform process;
Putin’s 5th term as president of Russia and Biden’s growing weakness on Gaza, could tilt the US presidential race in favor of Trump. The latter would cement the East-West divide and isolate Western Europe. If Putin dials up his war in Ukraine (as he has promised), there is a possibility of an oil price shock that Pakistan will struggle to manage.
