Presentations

• 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;
• 2^nd 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 5^th 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.

• The Feb 8 elections went smoothly, and the initial results looked credible. Within days, however, accusations of rigging in Sindh and Punjab were raised by PTI and GDA.  The US and UN have taken notice and urged the authorities to resolve these issues within the legal framework and not use heavy-handed measures;
• In a TV interview, Maulana Fazl specifically identified ex-Generals for interference in the 2018 elections and for orchestrating the vote of no confidence that ended IK’s term as PM;
• The Rawalpindi Commissioner confessed that he rigged 13 NA seats, where PML-N candidates were declared winners despite losing the popular vote;
• It now appears the election plan was implemented in Sindh, but not properly executed in Punjab. PTI and GDA are demanding a judicial commission to investigate the rigging;
• PDM 2.0 is being formed, but initially lost steam as PPP refused to accept any ministerial positions. It now appears the establishment is pushing for this coalition, even though no party is keen to take charge of the economy;
• The IMF will only talk to the new finance team and will want a commitment from the Treasury and Opposition benches before discussing a longer-term IMF program;
• The CA deficit in January was $ 269 mln. While this is disappointing, Pakistan’s BoP position is still comfortable as exports are doing well and remittances are stable;
• The fall in inflation will be less pronounced as fuel prices have increased, and people prepare for the sharp hike in gas tariffs. Our avg. inflation projection for FY24 is now 26.7%, which means interest rate cuts are unlikely;
• Although SBP’s FX reserves remain comfortable, weekly dips and the delay in the 3^rd tranche could create some anxiety;
• PDM 2.0 is likely to take charge in the Center, but the unrest in Balochistan and interior Sindh will not create a stable country;
• The choice of the next finance minister is eagerly awaited as this would shape Pakistan’s negotiations with the IMF. There is a dominant view that Ishaq Dar would be a recipe for sovereign default, but he is unfortunately NS’s first choice;
• If the new government is sworn in by early March, the 2^nd IMF review mission will arrive by mid-March, which means the SBA is already delayed by one month. Time is working against GoP as Pakistan will slip into defacto default the longer the IMF uncertainty remains;
• Since the new government will not be able to deliver on the heavy to-do list, we think the IMF may offer another 9 or 12-month SBA to give PDM 2.0 more time to generate support for the structural reforms. If the Fund insists on the to-do list upfront, Pakistan will default.

• The IMF approves the 2^nd tranche on Jan 11^th, which is deposited on Jan 17^th;
• SBP has managed the rupee and its FX reserves well, creating a sense of stability in the markets. Trade flows are supporting SBP’s policy stance, as December’s CA posted a surplus of $ 397 mln – liquid reserves are also above $ 8 bln;
• The IMF Staff Paper is disappointing as it is light on reform details and only has targets till December 2023. However, there is urgent focus on the gas sector, the need for a mini-budget, and specific risks (i.e., timely disbursements of external inflows, exposure of banks to the sovereign; and governance and transparency issues related to the sovereign wealth fund (SWF) and SIFC;
• Economic stability and the appreciating rupee have shored up domestic demand. Sales of white goods have leveled off, but an increase in import demand will be a problem for SBP.  We expect the rupee to start depreciating;
• The picture of structural reforms is mixed. Tangible steps have been taken on the power sector (federal control) and SOEs (new SOE law and the performance report), but there are no details on expanding the tax base (retailers and the agri sector), specific plans for restructuring discos, gencos, and NHA, and nothing on consolidating the overlap between the federal and provincial governments;
• We are concerned about the standoff between the SIFC and the Senate (now FBR), where the Senate has questioned whether the SIFC has the mandate to implement institutional reforms;
• The economic agenda facing the next government is daunting and politically sensitive. People have rightly questioned whether the next government will have the credibility to see the reforms through;
• Pakistan faces defacto default if the ongoing SBA and/or the expected EFF are interrupted. Foreign suppliers may demand upfront $ payments to ship goods if they think the IMF program will be derailed;
• The political outlook is getting murkier. PPP is attacking PML-N (sensing that PTI is out of the political arena); PML-N is off to a very slow start (sensing its relations with the establishment will ensure election success); and PTI is being impeded at every step of the way;
• Donald Trump appears certain to be the Republican nominee and has a strong chance of being the next president. This complicates how US policies in 2024 will be received globally.  If he wins, this could create a more balanced multipolar world and resolve the ongoing wars in Ukraine and Gaza;
• Pakistan and Iran exchanged missile strikes, but tensions were quickly defused. While future engagements are unlikely, the underlying tensions in greater Balochistan (on both sides of the border) could destabilize the region and undermine the February 8^th

• There is a tangible improvement in Pakistan’s macro economy, with stability and policy certainty;
• BoP is comfortable and the resulting stability of the rupee has anchored market sentiments. SBP is managing its FX reserves with a zero current account policy, which means banks should manage $ inflows and outflows without looking for central bank assistance;
• The delayed IMF tranche is not a source of concern, and the market expects the tranche and other inflows from the IFIs by mid-January 2024;
• The accompanying IMF Staff Paper should spell out details of the SBA and the first year of the anticipated 3-year EFF. This should energize the reform agenda well before the elections in February 8^th;
• YoY inflation is falling on the back of regular cuts in retail fuel prices that started in October 2023. The market is convinced that interest rates will be cut in January 2024;
• The outstanding volume of OMOs has stabilized in the past several months, which could be linked to the ongoing SBA. However, if the IMF wants to see this artificial liquidity reduced as part of the SBA (and subsequent EFF), the interest rate cuts will be smaller than anticipated;
• The recent correction in the PSX was expected. The hope is that with some stability in the stock market and attractive valuations, foreign portfolio inflows could increase;
• The outlook for the war in Gaza remains very uncertain. Netanyahu has recently said he is against the 2-state solution, which contradicts the US and EU.  Increasingly, Netanyahu’s government is being criticized by the West for its indiscriminate bombing of Palestinian civilians;
• The real issue in Pakistan is the growing political uncertainty. Although an election date has been set, there is widespread skepticism that the election will be free and fair;
• With the Establishment calling the shots, there is a strong sense that it will play a pivotal role in creating a coalition government that it controls;
• However, unlike the Charter of Democracy that allowed for political stability in the 2008 and 2013 elections, conditions are very different now. The consensus is that the coalition government will be weak, which is raising doubts about its ability to champion tough structural reforms;
• Using AI, Imran Khan is now telling his supporters to participate in the elections. PTI will play the role of the spoiler in the Establishment’s plan for the next government;
• We end by acknowledging that there are two views on the economy – Half-Full or Half-Empty. Both sides have convincing arguments to support their view.  We tend to align ourselves with the Half-Full school on the assumption that economic reforms take center stage irrespective of politics.  Politicians and people must understand that any interruption in the next EFF (at the negotiation or implementation stage) means instant default, which has a very heavy price.

• The first SBA review is a success, and the 2^nd tranche should be released on schedule. The caretaker setup should be given credit for steadying the economy;
• There are follow-up issues, but none are deal breakers. Specifically, the external financing gap for FY24 remains, but there should be adjusters in the NIR targets; also, the revenue target (and primary surplus targets) remains hard, which means the likely revenue shortfall will be met via backup measures (windfall tax on banks, real estate taxes/valuations);
• Formal steps to expand the tax base and action on SOEs will be left for the next government. The caretakers have provided a plan, but the next government will have to deliver with action;
• The external sector is remarkably stable. FX reserves have held up, and SBP has managed the rupee to settle anxieties.  Pakistan should experience another boost to its reserves with the release of the tranche (and other IFI money) and manage a slow fall in liquid reserves;
• Interest rate expectations have changed, and the market now expects a cut in early 2024 – this is supported by the fall in YoY inflation;
• A stable rupee and the cut in fuel prices have reduced our inflation projections (average inflation in FY24 is predicted at 22.9%, which is just above SBP’s 20-22% range);
• Demand management via the fall in wealth linked to real estate holdings (the deemed income tax on empty residential/commercial plots), has reduced imports and the demand for consumer durables. This will be especially challenging for the auto sector;
• $ repatriations have increased in the past several months after a period when SBP effectively disallowed outflows;
• While an election date of February 8^th has been announced, there is not much enthusiasm. There is a clear sense that PML-N is favored by the establishment, which has been flagged by PPP and is being monitored by external stakeholders;
• The economic improvement could be short-lived if the next government is elected by a low voter turnout. The next government must be strong to push through hard reforms, which depends on its credibility (i.e., popular support);
• The massacre in Gaza continues as Arab leaders take a back seat. Earlier fears of an East-West divide have not materialized as Biden tries to return to the status quo.  This will not work, as US views are increasingly at odds with what Netanyahu wants.  This issue could still escalate;
• If Israel’s operations against Palestinian civilians continue unchecked, religious parties in Pakistan may take a hard stance and change the political narrative in the forthcoming election. A strong anti-US reaction will complicate the political outlook.

• Rupee appreciation and cut in fuel prices help sentiments. However, this feels like a comfortable limbo where underlying uncertainties have not been resolved;
• Lack of news on the SBA from the meetings in Marrakesh was unsettling. However, subsequent data releases show that GoP has managed to meet key performance criteria (primary surplus, FBR revenues, NIR, NDA, GoP guarantees, etc.), which means the forthcoming IMF review mission should be successful;
• World Bank Group (WBG) warns that GoP’s privatization plans could face litigation for not being competitive and transparent. This undermines the mandate of SIFC;
• The $ financing gap in FY24 has been acknowledged by both the IMF and MoF. This is strange as the IMF does not support a reform agenda unless the external gap is fully funded.  We expect this issue to be resolved after the review mission;
• Clampdown on money changers (MCs) reduces capital flight and is reflected in higher remittances in September. It also reduces the kerb rate and brings down the premium;
• OMO data has been revised, which shows the outstanding volume of OMOs falling in the past two months. This could reflect the positive developments on the revenue side;
• The inflation outlook has improved in the past month as the rupee gained and fuel prices were cut. Our avg inflation prediction is now 22-23%, which is close to SBP’s estimate;
• The IMF review mission is expected on 2^nd This should be successful, but we sense that preparatory legislation will be required to increase the tax base and to bring the provincial and federal governments on the same page;
• CAD in September fell to just $ 8 mln, driven by subdued imports and the remittance spike. Pakistan’s BoP remains comfortable unless there is an oil price shock (Gaza);
• NS returns to Pakistan aided by the state. His political message is outdated, and his alliance with the caretaker setup is obvious.  PPP fears manipulated elections to bring PML-N back into power and stepped up criticism of the caretakers.  It also says that PTI must be allowed to contest.  We see common ground developing between PPP and PTI;
• The war in Gaza has been raging for the past three weeks, and the impact on Palestinian civilians is heart-wrenching. The West has not pushed for a ceasefire, and Netanyahu has formed a unity government to achieve his goal of exterminating Hamas;
• Hezbollah has warned that if the ground offensive starts, it may get involved. While the US has taken a clear stance, China/Russia & Saudi/Iran are perhaps planning a united response.  One idea is an oil embargo against Western countries (ala 1973) – OPEC+ is well placed to do this.

• In a surprise move, both the ECP and Caretakers announced they would obey the decision of the Supreme Court (SC) regarding the date of the general elections. The SC has been consistently saying that elections should take place within 90 days, which means elections are likely in November.  This means a change in the game plan by the Caretakers (i.e., establishment);
• With the slide of the rupee and the sharp increase in sugar prices, the Caretakers moved hard against moneychangers, smugglers (Iranian fuels), hoarders (dollars and sugar), power theft, and unpaid bills. The rupee stabilized, and the PSX has recovered;
• SBP’s FX reserves continue to fall, but the central bank can manage the pace by controlling the pace at which delayed $ payments are cleared. With a sharp fall in aggregate demand, it appears that Pakistan’s BoP is manageable, as monthly imports should be financed by exports and remittances;
• Caretakers and the establishment appear to pin their hopes for economic recovery on substantial inflows via SIFC. This may not materialize in the short term as FDI flows are staggered and encumbered and cannot be used to provide relief to the people;
• With global oil prices rising and zero fiscal space, fuel prices will increase further. Furthermore, the expected gas price shock (with three months of arrear payments and higher tariffs) will further burden the common man;
• Our average inflation projection for FY24 is 30.4%, with a significant YoY spike in September and October. Our rupee prediction of Rs 336.7/$ by June 2024 is slightly worse than the average projection of a survey of analysts.  Hence, claims that the rupee could fall to Rs 360-400/$ by June are exaggerated.  One must realize that a weak currency has a direct impact on the circular debt, which is now a policy priority;
• SBP surprises the market by not increasing the benchmark rate. This is despite elevated inflation and a likely spike in the next two months.  This calmed market expectations, and rates may remain stable for a few months;
• The change in the Chief Justice of Pakistan (CJP) could herald a new beginning for the SC. Justice Isa has called a full bench hearing of the Practices and Procedures Act 2023 and said it will be telecast live on TV.  This unprecedented move could generate public support for the SC and give it the moral authority to make sensitive decisions (e.g., date of elections, IK incarceration and political ban, and heavy-handed security laws).  This could resolve the political confusion that currently exists;
• The most significant development in the past month is the sudden collapse of disposable income. This has impacted retailers/eateries/service providers very hard and is likely to spill over in terms of job losses.  Managing this cost-of-living crisis has become the government’s top priority, but there is no fiscal space to make life easier;
• The upside of this economic pain is that public anger against the Discos and the international embarrassment created by PIA, has created a constituency that will push for real reforms in dysfunctional SOEs. This goal has eluded the country because of political and institutional push back against reforms.

• Pakistan is facing a constitutional crisis with President Alvi disowning two key legislations (Official Secrets Bill 2023 & Pakistan Army Bill 2023). These laws are instrumental in arresting PTI leaders and the trials against PTI supporters. The Supreme Court (SC) will have to get involved;
• The Caretaker setup is sworn in. The cabinet is mainly professional, with an establishment tilt and some business insiders. The economic team of Shamshad and Waqar Masood is seasoned and pro-IMF;
• The Caretaker’s economic agenda is simple: SBA; SIFC; circular debt; and SOEs. We do not expect much in terms of expanding the tax base (to capture retailers and agri) or restricting spending by the government and the army;
• The ECP has announced that general elections will be delayed by four months to complete the delimitation exercise based on the 2023 census. The general public, political parties, and media outlets are split on the delay, but external stakeholders may prefer elections in 2024;
• We anticipate a positive first meeting between the Caretaker government and the IMF. With the priority attached to SIFC, we think the SBA parameters should change to reflect a better BoP outlook;
• The Caretakers have started their term by sharply increasing fuel prices, power tariffs, and allowing for a weaker rupee. This will unleash another bout of inflation – our projection for avg inflation in FY24 is now 31.8%;
• This, coupled with taxes on real estate holding and transactions, will sharply reduce aggregate demand. Elites are experiencing a negative wealth effect, while the middle class is struggling with the sharp increase in power tariffs and fuel prices;
• The current account deficit (CAD) surprised the market when it posted a deficit of $ 809 mln in July. This can be traced to clearing import and service payments arrears as GoP has committed to removing all restrictions in the SBA. In our view, the trade deficit and service outflows will remain elevated in the next several months;
• Remittances continue to trend down, which can be traced to capital flight. The latter could be due to political uncertainty, repressive legislation, and the liquidation of real estate assets. Pressure on monthly remittances is likely to stay in play during FY24;
• The next few weeks (month) are critical as several issues will play out: (1) How will the Supreme Court respond to the constitutional crisis, and how will the establishment react to this; (2) How will the Caretakers respond to the acute austerity the economy will likely experience? We argue that this episode of slow economic growth could be much worse than previous episodes of austerity; and (3) How will the country respond to the delay in general elections?

• Securing a 9-month Standby Arrangement (SBA) at the last minute has completely changed Pakistan’s economic outlook. From certain default, SBP’s FX reserves have jumped to $ 8.7 bln, while the rupee appreciated and PSX booms;
• SS gets credit for his direct intervention to secure the SBA;
• IMF Staff Paper is critical of Dar’s management of the rupee and SBP’s subservience. It says the downside risks associated with the SBA are “exceptionally high,” a clear reference to past slippages and the fact that this is an election year. However, the IMF has warned that Pakistan faces a narrow road to recovery, and if program targets are not met, multilateral/bilateral flows could be delayed, which effectively means sovereign default;
• SBA to focus on the kerb premium, tax on retailers and real estate holding/transactions, power tariff increases, gas supply chain, restructuring SOEs, and releasing quarterly GDP data. The FX reserve buildup in FY24 is limited, which means the external sector will operate on a tight leash. The SBA does not see any structural change in Pakistan’s trade sector, and its medium-term BoP projections are not credible;
• June’s current account balance posts a surplus of $ 334 mln, which brings down the CAD in FY23 to only $ 2.6 bln. This was necessary but also took a significant toll on the economy. Non-oil imports fell by 35%, which has a direct bearing on underlying economic activity. The IMF claims that growth last year was negative 0.5% and downgrades GoP’s growth projection for FY24 from 3.5 to 2.5%;
• The IMF also projects avg inflation in FY24 at 25.9%, which is very close to our projection (26.4%). This means interest rates will remain elevated and may even rise in the months ahead. With the sharp erosion of household wealth (which saves primarily in real estate), we think aggregate demand will fall and contain import demand. The IMF’s CAD projection of $ 6.4 bln I FY24 is reasonable even if import restrictions are lifted;
• SS is looking good and is confident about being reelected, but the path for PML-N is unclear. Punjab is the political battleground, with PML-N, IPP, and PTI contesting – the establishment is also rooted in Punjab. This uncertainty will impact the composition of the federal government;
• As part of the systematic effort to weaken PTI, PTI-Parliamentarians has been created by Pervez Khattak in KP. While IK remains tied up in a litany of court cases and is barred from making public statements, we think he will become more vocal as the campaigning starts;
• Most analysts see a weak coalition government in the future. The establishment will be a decisive player, but it must be careful to ensure the forthcoming elections are not perceived as stage-managed.