Presentations

• GoP has delivered on all prior actions, but the IMF still wants written commitments from bilateral friends to commit $ 6 bln before the SLA is offered;
• This means a wait for another month before Pakistan sees lumpy $ inflows;
• Current Account posted a surplus of $ 654 mln in March. The 9-month CAD is only $ 3.4 bln, which has allowed SBP to keep the rupee and FX reserves stable during the last six weeks – the pressure is off for now;
• Inflation hit a record 35.4% in March, and with fuel prices still increasing, we expect inflation to remain elevated well into FY24. The economic pain on the poor and lower middle class is unprecedented, and the government is not managing this as the emergency it has become;
• SBP hikes interest rates by a further 100 bps, with expectations that an additional 200 bps increase is likely. This will squeeze government spending and could result in delayed payments, including government salaries, in the coming three months;
• The political crisis has become a constitutional crisis. All parties (legislature, judiciary, executive, opposition, and army) share the blame for this state of affairs. The petty back-and-forth between the legislature and the judiciary cannot be resolved without mediation;
• After its verdict on the 14 May elections in Punjab, the Supreme Court is directly instructing state institutions like MoF, SBP, and ECP to follow through and report progress;
• Zardari’s suggestion for unconditional talks between PTI and PML-N may be on behalf of external stakeholders who want to avoid a messy default;
• We suggest a possible timeline: talks after Eid; a joint statement that it is wrong to politicize state institutions; judiciary also backs off; SLA is signed; a suitable Budget is announced (without any political handouts); PDM announces that it will hand over charge to caretaker setup in early July; combined $ inflows from IFIs and bilaterals shore up SBP’s FX reserves; this is gradually drawn-down by caretakers till elections in October; IMF starts negotiating the next EFF with the newly elected government;
• From the recent behavior of the IMF, we sense that Pakistan may become a pawn in the tussle between the US and China in how to manage third-world debt. The US wants China to take a hit from overlending in Asia and Africa, but China wants the burden to be shared with multilaterals;
• GoP has been silent on the matter, accepting the IMF’s viewpoint. To avoid a state of limbo, policymakers need to initiate bilateral talks with China, Saudi, UAE, & Qatar, to see if Pakistan’s debt can be swapped for assets. Only by easing the stream of future $ repayments will Pakistan be able to embark on credible economic reforms.

• Relations with the IMF are tense. The authorities are blaming the IMF for delaying the staff-level agreement (SLA), while the Fund is unhappy with the direct credit line for GoP and is weary of GoP’s desire to cross-subsidize fuel to provide relief for less affluent households;
• The IMF also has reservations about GoP’s lower external financing requirement, which means a smaller CAD (by continuing to delay payments) and a slower build-up in SBP’s FX reserves. Although a compromise has been reached, we think this makes EFF Part 2 inevitable;
• The IMF is also demanding written guarantees from Pakistan’s friends that they will release fresh funding when the EFF is approved. The FY24 budget will be an important marker that the IMF will closely watch. With mounting economic pain and pending general and provincial elections, PML-N will want to include some handouts to regain political capital;
• Headline and food inflation have hit record levels, and there is little relief in sight. For February, YoY inflation was 31.5%, while food inflation exceeded 45%. Public anger is mounting;
• The CAD for February was only $ 74 mln, and the falling trend has been in play since July 2022. But this improvement will not help sentiments as it reflects the significant squeeze on the real economy;
• SBP surprised the market by hiking interest rates by 300 bps on 3rd March. This will not reduce inflation, but it will squeeze government spending when the elevated borrowing rates are paid out in three months;
• Pakistan’s FX repayment position is getting dire. As of end-January 2023, repayments in the coming year are $ 23.6 bln while SBP’s FX reserves were only $ 3.1 bln. Pakistan needs to restructure its external debt;
• Open market operations (OMOs) have also reached record levels. As of end-February 2023, SBP had injected Rs 6.3 trn into the money market. Since this liquidity can also be used for imports, the IMF will likely impose containment measures. This means interest rates are likely to increase further;
• Domestic politics continues to dominate the airwaves. There is much talk about arresting and disqualifying IK, but we argue this will do little to change PTI’s political trajectory;
• The more relevant question is whether elections (provincial and general) will be postponed. We argue that two groups have been formed: those who want elections as per the Constitution (Supreme Court, PTI, civil society, mainstream media, and external stakeholders); and those who want to postpone elections (Maryan Nawaz & the Supremo, ECP, the caretaker governments in Punjab and KP, the army and its agencies);
• We think the preferred path is to stick to the Constitution and hold elections.

• IMF mission arrives and shares the Memorandum of Economic & Financial Policies (MEFP). Staff-level agreement is when the authorities sign the MEFP. IMF Chief signals that Pakistan must bring more people into the tax net, and hints that there is no plan for debt forgiveness;
• Dar lets the rupee go on 26 January, which moves from 230.7/$ to 275.2/$ on 3 February, but has gained some ground. It triggered sales from exporters who were holding back;
• A minibudget was announced on 15 February and included many prior actions. Gas & power tariffs have been raised; GST has increased to 18%; fuel prices were hiked; luxury tax was imposed; and FED is charged on sugary drinks, cigarettes, and business class air travel. Dar claims the IMF has agreed not to impose GST on fuel;
• These steps will spike inflation, and our projections show that average inflation in FY23 will be just above 30%, while food inflation could average 40% in the year;
• FX reserves keep falling, dipping below $ 3 bln in early February. BoP data shows that SBP has lost over $ 7 bln from July to January 2023. Even if the EFF restarts, the next tranche of $ 1.2 bln may not be released till mid-March;
• Remittances continue to fall, reaching $ 1.9 bln in January from a recent high of $ 2.7 bln in August 2022. However, with a more realistic rupee parity, we think remittances will increase in the months head;
• There is much talk about an emergency MPC to hike interest rates – this may be a prior action. We expect a 200 bps rise in the coming days. Further increases will depend on whether the IMF imposes a ceiling on outstanding OMOs;
• January’s current account deficit (CAD) was $ 242 mln, only 10% of the deficit in January 2022. Non-oil imports are down 32% in the seven months of FY23 compared to FY22, which shows the squeeze on the real economy;
• BoP data shows that in these seven months, the Financial Account posted an outflow of $ 3.2 bln compared to an inflow of $ 11.6 bln in the same period in FY22. Service payments were only $ 301 mln compared to $ 2.7 bln last year, as SBP has stopped making service payments;
• Imports show a sharp fall in auto parts and oil, but food imports remain elevated. Textile exports also post a steady decline;
• We argue that the rise in public anger makes it unlikely that PDM will remain a united coalition, which raises the possibility of Plan B (a three-year interim government to focus on the economy and stay on track with the current EFF and the next EFF);
• Since only IK (and PTI) will lose with Plan B, IK has stepped up his attacks on Retr General Qamar Bajwa as a way of putting pressure on the army not to delay elections;
• We also argue that all external stakeholders would prefer Plan B as this will ensure that Pakistan does not experience an economic and social collapse. Since these stakeholders are now calling the shots ($s and IMF seal of approval), their interests may prevail.

• IMF demands are precise: (1) fix the exchange rate; (2) increase power and gas tariffs; (3) release a minibudget with new revenue measures; and (4) impose GST on fuels;
• GoP is now saying it would like to negotiate these conditions with the IMF. Negotiating prior actions is a non-starter, which means this is political spin: beg the IMF mission to visit Pakistan, and then adjust the rupee, and deflect the blame onto the IMF;
• SBP has revoked the approval stage for LC confirmations, effectively shielding it from criticism and shifting the blame onto commercial banks. This may further squeeze LCs, as banks become more cautious about committing to $ payments when they know that SBP will not help;
• The sharp reduction in imports has triggered widespread layoffs and is angering businesses across the country. Non-oil imports have dropped by almost 30% in 1H-FY23 compared to the same period a year ago;
• The kerb premium could be as high as 35-40/$ and will require a one-shot adjustment. This will spike inflation and trigger public anger;
• The kerb premium is shifting remittances to the kerb market and delaying export receipts. SBP’s exchange rate policy has failed, but the central bank appears powerless to change it while Dar is in charge;
• Imposing GST on fuels will be politically difficult and expose the lie that GoP wants to restart the EFF but not burden the common man;
• FX reserves continue to fall despite a declining external deficit. In the past 18 months, SBP’s reserves have fallen by almost $ 12 bln. Pakistan’s BoP problem is now structural and cannot be solved without comprehensive debt restructuring;
• Inflation is likely to experience a surge when the IMF’s prior actions are implemented. Food inflation could average 34% in FY23 and exceed 40% YoY in February 2023. Food inflation has already become a national crisis and could have dire political consequences for PML-N;
• Instead of guiding the economy, GoP and SBP are finding scapegoats and resorting to political spin. This inaction will not only anger the business community (which is PML-N’s vote bank) but also result in nationwide shortages of essential items – this has played out in Sri Lanka;
• Since the economic team has lost all credibility, the best hope is an empowered caretaker setup that declares a state of emergency and restarts the EFF. We are surprised the establishment is so passive when the country is facing an unprecedented economic/political crisis;
• With the dissolution of the Punjab Assembly and KP likely to go the same route, domestic politics remains a mess. PML-N is fighting for its political survival, but its inaction on the economic front could be the final nail in its coffin.

• There is no clarity on Pakistan’s relationship with the IMF. The 9th review will be delayed till January 2023, which means the next tranche may be delayed till February;
• We expect tensions on the growing circular debt, the strict management of the rupee, insufficient tax revenues, and the delay in imposing GST on fuels;
• While Dar continues to say the economy is moving towards stability, the State Minister of Finance has recently admitted that things are not well. A social media story listing nine emergency measures goes viral, which reveals that the market expects emergency steps soon. The artificial calm projected by policymakers is undermining business confidence;
• Strict import curtailment is choking the domestic economy. In the first five months of FY23, non-oil imports are down 29% compared to FY22, with reports of widespread layoffs as manufacturers reduce shifts because of inadequate imports;
• The government is taking no steps to rethink its external debt. Debt repayments between Nov 2022 to Oct 2023 are over $ 26 bln compared to less than $ 6 bln in late 2017. SBP is trying to shore up confidence by listing $ inflows and outflows in FY23, and arguing that arrangements are in place to meet all $ repayments (while strictly limiting import LCs);
• The current account deficit in November shrinks to $ 276 mln, which means the full-year CAD will be smaller than projected. However, with remittances edging down (distortions in the FX market) and a poor outlook for exports, the BoP problem remains. With SBP’s FX reserves falling to a four-year low, the market cannot shake off fears of default;
• Getting on track with the EFF will be difficult. We expect prior actions on: FX management; GST on fuels; power tariff increases; and some steps to target loss-making SOEs. This is politically unpalatable, which explains the government’s muddled outlook;
• We list eight necessary structural reforms that will be difficult to implement. We wonder if the IMF may seek some guarantee that these measures will be taken (via a charter of economy type arrangement);
• Global oil prices are unexpectedly soft despite the price cap on Russian oil exports. With winter getting worse in Europe, we fear that oil prices could start climbing;
• IK announces 23rd December as the date for the dissolution of the Punjab and KP governments. This will energize domestic politics but do little to provide an economic roadmap.

• Frantic political developments dominate in November. Army felt compelled to counter misinformation in an unprecedented press conference by the ISI chief;
• There was an assassination attempt on IK on 3 November, in which he was injured. One was killed, and 14 were wounded. IK accused Shehbaz Sharif, Rana Sanaullah, and a senior ISI officer for the attack, but could not name them in the FIR. IK also mentioned a second shooter, which the government has dismissed;
• Anticipation is building on the choice of the next COAS. Commentators claim that the decision will determine whether early elections are held, which may provoke a political reaction;
• Dar is trying his best to calm market fears of sovereign default but to no avail. 5-year CDS spreads signal pending default with only weeks till the 5 December Sukuk maturity. The fact that the IMF and MBS (of Saudi Arabia) have delayed their trips to Pakistan adds to the sense of despair;
• Analysts claim the 9th review will be delayed till December, and even if the negotiations are successful, the next tranche will not be released till January 2023. In our view, approval will require prior actions that could be painful;
• The IMF is not convinced about the flood-related economic damage proposed by the authorities. Hence, the Paris donor conference has been delayed. Four months after the deadly floods, international assistance for humanitarian assistance is already too late;
• Inflation remains elevated, with October’s YoY increase at 26.6%. Our projection for average inflation in FY23 is 28%, based on a potential rise in oil prices in December/January and a weaker rupee when the 9th review begins. We argue that inflation is a slow burn, and the loss of purchasing power and increase in poverty could have political repercussions;
• October’s CAD comes in at $ 567 mln, which shows that SBP’s import restrictions are working. However, the 27% fall in non-oil imports in Jul-Oct 2022 (compared to a year before) shows that the economy is being squeezed;
• The exorbitant kerb premium is reducing monthly remittances and creating unease about the artificial strength of the rupee in the interbank market. This could sour the negotiations with the IMF;
• The pending decision of the COAS, the 26 November PTI show of force, and the maturity of the Sukuk, means the next two weeks will be uncertain. One thing is clear, however, political clarity is now a prerequisite for economic clarity.

• Dar takes charge of the Ministry of Finance and dominates proceedings. With no change in fundamentals, the rupee begins to appreciate, and the PSX starts trending up.  He then cuts fuel prices as part of his mandate to provide relief;
• In response, the IMF warns against the use of untargeted subsidies, while the World Bank stresses the need to stay on track with energy sector reforms;
• The devastating floods no longer dominate the news, but the damage is significant. The IFIs and UN have estimated the cost at $ 32.4 bln, which is about 11% of GDP.  GoP estimates that this will pull down economic growth to 2%, and put pressure on the external sector for the import of wheat and raw cotton;
• A donor conference is planned to take place in Paris, and policymakers are expecting significant $ commitments. However, it is unclear if the flood relief will come with conditions on how the funds can be used;
• Pakistan’s BoP remains precarious, even though the CAD for September was only $ 316 mln. At this run rate, FY23’s CAD will be below $ 9 bln, which is within the target set in the September 2022 IMF Staff Paper.  However, this improvement has been achieved by discouraging non-essential imports, which means pent-up demand is being created.  In our view, the authorities are hoping that the $ inflows expected from the IFIs and donors should be sufficient to clear this backlog;
• Remittances fell in September to $ 2.4 bln, which surprised us as we expected more generous inflows on account of the floods. However, with the abnormally high kerb premium, some of the inflows may have been routed through the Hundi/Hawala system;
• RDA inflows have also slipped, but remain remarkably stable despite the political uncertainty. With most expats aligned with PTI, we argue that the call for early elections (with IK’s growing popularity) could see stronger inflows into the country;
• We flag the falling ratio of currency in circulation to total deposits as a positive development, which could be responsible for the lower outstanding volume of OMOs. We think this could be traced to a sluggish real estate sector and more restricted spending on consumer durables;
• Import restrictions have brought down non-oil imports, but the sharper fall in oil imports could be traced to the lack of rural demand on account of the floods;
• Inflation dipped in September to 23.2%, driven by a sharp fall in YoY inflation in the utility sub-index. This came about because of a waiver on the fuel cost adjustment in the month, which allowed power tariffs to be reduced for small consumers (these rates are used in the CPI basket);
• The East-West divide is widening, which complicates the debt rescheduling/relief that Pakistan needs;
• We end by highlighting Dar’s gamble, where he needs to deliver on his political mandate (provide relief and bring down inflation) while keeping the IFIs engaged. We also argue there is no coherent plan to repay Pakistan’s $ debts in FY23.

• The rupee’s slide has dominated public attention. Business sentiments are bearish as the market expected the EFF to stabilize the economic outlook.  Delayed SBP approval for LCs has angered businesses and is stalling the formal economy;
• The devastating floods prove that Pakistan is one of the most vulnerable countries to global climate change. The humanitarian and economic damage will take months to overcome, and the economy will slow down.  The uneven recovery in the provinces could have political repercussions;
• Donor grants have not been as forthcoming as expected. Climate-related damage, a global economic slowdown, and Pakistan’s poor image are responsible;
• The IMF Staff Paper was issued, but this depicts a pre-flood scenario. Flood damage and donor relief will change the performance criteria in the EFF (e.g., fiscal & BoP targets, SBP’s FX reserves, etc.) but may not change structural benchmarks (SBs).  The fact that Pakistan has achieved little in this stop-start EFF, has resulted in more conditions imposed on the country.  In the February Staff Paper, six new SBs were included, and the new one adds a further eight.  In total, the authorities must meet 18 SBs by end-June 2023, and since some are politically sensitive, we do not expect a smooth time in the EFF;
• Inflation has crossed 27% and is likely to remain stubbornly high in FY23. However, SBP is not likely to hike interest rates, as this will do little to curb inflation but could trigger a fiscal blowout.  Public anger is mounting about the IMF conditions, especially the inflated electricity bills;
• The IMF Staff Paper states that SBP will only increase its FX reserves by $ 984 mln from end-June 2022 to end-March 2023. This means Pakistan is looking at back-to-back IMF programs in mid-2023, and the FX market will remain jittery in the coming year;
• The economic slowdown will support the EFF by keeping Pakistan’s BoP under control. The first two months of FY23 have seen a sharp fall in the monthly CAD, but the size of the external deficit is no longer the problem.  Heavy debt repayments and low FX reserves are the main concerns;
• The tempo of domestic politics has eased since the flooding started, but this is likely to change soon. IK has announced a rally on 24 September to demand early elections.  With the mounting economic uncertainty and poor business sentiments, public opinion is stacking up against the coalition government;
• Global developments reveal a growing East-West divide. China, Russia, and India have effectively boycotted the UNGA session this month, as they knew the West would focus on Russia’s invasion of Ukraine.  The eastern bloc is seeking to attract countries to trade with Russia against the explicit demands of the US.  This divide will be difficult to navigate for Pakistan, which has expressed interest in buying discounted oil and gas from Russia.

• Devastating floods have been the worst since 1961. Rural areas in KP, Sindh, and Baluchistan have experienced substantial loss of life and livestock, while villages and road/rail networks have washed away.  The authorities are still unsure about the loss of agricultural production;
• Local governments haven’t been able to cope amidst growing public anger. It is unclear how this will change the political mood in the country;
• Domestic politics is again in crisis as terrorism charges are leveled against IK. PTI supporters have warned of mass demonstrations if IK is arrested;
• The coalition government is standing firm, not just to groom the next generation of dynastic leaders but to eliminate PTI from the political landscape. Further efforts to sideline IK will only make him more powerful;
• Fears of sovereign default have subsided: GCC countries have committed funding for FY23, the IMF has said that prior actions are complete, its board will meet on 29 August, and steps have been taken to reduce imports. The rupee appreciated in the first two weeks of August, triggering a bull run in the PSX;
• While the EFF is a source of comfort for the market, program details will be sobering. This should include: reforms of loss-making SOEs, the need for a more equitable tax burden, growing bank deposits to finance both the government and the private sector, efforts to control the two circular debts, and additional spending to rebuild the infrastructure that the monsoon rains have destroyed;
• While Miftah Ismail deserves credit for stabilizing the economy, he is sending mixed signals. The reversal of the ban on luxury imports, his promise of relief for importers, his admission that PML-N’s leadership is not happy with fuel and utility price hikes, and the recent decision by SS to take back the fuel cost adjustment in electricity bills, does not give much confidence that the ruling government will follow through with its commitments to the IMF;
• SBP holds the benchmark rate at 15%, claiming that import containment measures are working and should be given more time – this is notable as July’s inflation rate hits 25%. M2 growth has been high in the past two years, driven by OMO injections that will need to be reversed;
• Global conditions remain challenging with the ongoing war in Ukraine that could spike oil and gas prices in the winter. Furthermore, Europe is facing high inflation and possible recession, as is the US.  These countries are Pakistan’s main export markets, and there are indications that export orders have fallen.  Furthermore, with climate change causing chaos worldwide, analysts fear this could lead to famine.

• Pakistan is experiencing soft default: letters of credit (LCs) need SBP approval; interbank rates are posting large spreads; Pakistanis Eurobonds are trading at a deep discount; delayed $ payments are accumulating; and the rupee-dollar parity has witnessed record weakness in July;
• The IMF staff-level agreement (SLA) has been reached, but the conditions are more demanding. Revenue targets have increased, and so has the primary surplus target.  The IMF board meeting is scheduled for late August, which means managing the markets in August could be challenging;
• Efforts to reduce non-essential imports have rattled import-dependent businesses. Uncertainty about future LCs has forced auto assemblers to stop taking orders, while corporate profitability is likely to take a hit;
• The economy will experience a fall in domestic demand, a sharp increase in debt servicing (on domestic and external debt), reduced private investment, elevated inflation, and pressure to meet tax revenues targets;
• The unprecedented weakness of the rupee in July has dominated public attention. The CAD for FY22 was $ 17.4 bln, which is higher than expected.  June’s $ 2.3 billion deficit was driven by a record $ 2.9 bln oil imports;
• FX reserves continue to fall, which explains SBP’s reluctance to supply $s to the interbank market. Remittances have posted a record $ 31.2 bln in FY22, and we expect higher inflows this year as deteriorating economic conditions could result in more assistance from expatriate Pakistanis;
• The challenge of securing sufficient $s to restart the EFF highlights Pakistan’s shortage of FX. With FX reserves barely able to cover 45% of debt payments till May 2023, we raise the need to consider restructuring Pakistan’s external’s debt.  This means that Pakistan will have to speak to friendly countries (China, Saudi, and the UAE) to negotiate debt relief;
• The acute political uncertainty is hampering efforts to stabilize the economy. The political game between the PTI and PML-N in Punjab hints at more intrigue and confusion in the period ahead.  While most accept the urgent need to call for early elections and hand over charge to a caretaker government, the ruling coalition seems adamant about continuing till mid-2023;
• Although we are confident that Pakistan should restart the EFF soon, we do not expect the IMF to be accommodating. With a dozen developing countries heading towards default and Western countries facing recession (which will hurt Pakistan’s exports), restarting the EFF takes on greater significance.  Hence, FY23 will be a challenging year for the economy, which requires significant political will to ensure that Pakistan’s economy is stabilized.  GoP should declare a state of economic emergency and view this fiscal year as a period of consolidation.