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June 29, 2022

  • Revised budget to stay consistent with the IMF negotiations. Revenue shortfall will increase the burden on profitable corporations and high-income individuals.  Details on the wealth tax on real estate assets are still to be released.  PDL target of Rs 855 bln means fuel prices will remain elevated;
  • Primary surplus and FBR targets mean the EFF will be difficult;
  • Without a staff-level agreement, the FX market and PSX will remain vulnerable;
  • Three fuel price hikes have triggered public anger but do not appear to have dented demand;
  • May’s CAD hits $ 1.4 bln, with the 11-month CAD in FY22 now at $ 15.2 bln;
  • Rupee slide continues with a brief respite in recent days, while SBP’s FX reserves deplete. China’s rollover helps but will not change the trajectory;
  • We expect SBP to hike interest rates by 150 bps, but this will not change the country’s inflationary trajectory;
  • Managing the external sector will be challenging in FY23. The finance minister has said Pakistan needs $ 41 bln in FY23, which is unlikely to be realized.  We expect some form of debt restructuring next fiscal year;
  • While the IMF wants PDL and the GST imposed as soon as possible, the coalition government intends to stagger it as the public pain could undermine its popularity;
  • Imports show signs of easing as trade restrictions and a weaker rupee reduce demand. Rising interest rates also dampen consumer demand, especially for automobiles and motorbikes.  However, monthly exports are trending down, and with a global recession about to start, Western orders for textiles are falling;
  • YoY inflation hits 13.8% in May and could surge beyond 23% in June;
  • Revised budget reveals a degree of desperation to restart the EFF, but it is not clear what SS wants. The loss of political capital, possible disappointment in the Punjab byelections, and a tough EFF does not support the SS government’s aim to stay in power till 2023.  Perhaps the latter is driven by the goal of undermining IK’s popularity and grooming the next generation of the two political dynasties.  We argue that if Hamza Sharif cannot secure his government in Punjab, the PML-N supremo will pull the plus and demand early elections;
  • The war in Ukraine is driving the world into recession. The EU must cope with dwindling gas supplies from Russia, and experts are projecting a global famine.  While this conflict continues, global commodity prices will remain elevated, and Pakistan’s external sector will remain vulnerable.  However, we see the conflict moving towards a negotiated settlement.
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May 21, 2022

  • The coalition government rightly said that Pakistan cannot afford IK’s relief package (specifically the fuel subsidy), but the government still hasn’t increased fuel prices. This has dampened business sentiments as many feel the EFF is in doubt, and without the IMF, Pakistan is heading towards default;
  • The policy paralysis can be traced to the overwhelming political uncertainty. Coalition partners are divided about early elections and raising fuel prices, yet are putting across a false bravado about taking tough decisions;
  • Pakistan and the IMF have started the 7th review, which should pave the way to restart the EFF. The IMF has clearly stated that the fuel subsidy must be eliminated, which could become a prior action to resume the EFF in FY23;
  • The rupee has lost Rs 15/$ in May and there is no respite in sight. SBP’s FX reserves continue to fall, but the pace of decline has eased in recent weeks.  The market realizes that fresh inflows are not possible until Pakistan secures the next IMF tranche;
  • April’s current account deficit (CAD) was $ 623 mln, which shows that the external deficit is now under control. The import momentum appears to have eased and record-high remittances have contained the CAD;
  • Although Pakistan’s oil import bill continues to increase, non-fuel imports have started falling and will continue as the rupee weakens and new import restrictions are imposed;
  • SBP is unable to control market interest rates. Despite a 250 bps hike on April 8th, the market expects a further 150 bps increase, as inflation is rising and SBP tends to pointlessly chase inflation;
  • Food inflation (YoY) hits 17% in April, and headline inflation exceeds 13%. If diesel prices are increased to match international prices, YoY inflation could touch 25% in June 2022, and food inflation could be even higher;
  • IK’s rallies are capturing public attention as more TV channels are airing his populist speeches. The political/economic paralysis is playing into IK’s narrative, as he steps up his attacks on political dynasties, corruption, subservience, and US interference;
  • While coalition partners claim that they will serve their full term (till August 2023) we do not think this is possible. SS is caught in a Catch-22 situation: stay in power and be blamed for the economic pain, or call early elections and face criticism that he only came into power for selfish reasons (recall, IK dissolved parliament on April 3rd, which would have automatically triggered early elections);
  • The war in Ukraine could become unpredictable as the US/NATO seek a military solution. As the war continues, food and fuel prices will remain elevated, which means more BoP pressure on Pakistan.
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April 24, 2022

  • The past month witnessed frantic political maneuvering as opposition parties sought to topple IK’s government. After much drama on 3rd April, the Supreme Court had to direct parliament to carry out the vote of no confidence on 9th April;
  • IK was removed as PM and Shehbaz Sharif (SS) was voted in as prime minister on 11th April;
  • The US has refuted IK’s allegation that it sought regime change and interfered in Pakistan’s affairs;
  • The new finance minister (FM), Miftah Ismail, has said that IK’s fuel subsidy cannot be sustained. He has said several times that petrol prices are subsidized by Rs 21/liter, and diesel is subsidized by Rs 51.52/l.  Eliminating these subsidies will be politically difficult;
  • Discussions with the IMF have focused on the need to reverse IK’s relief package, and to stay on track with targets for end-June 2022. The FM has agreed to reverse the fuel subsidy, but said it would be impossible to come on fiscal track because of the mismanagement by PTI;
  • Pakistan’s current account deficit (CAD) was $ 1 bln in March, which shows a degree of consolidation despite elevated commodity prices. The $ 13.2 bln CAD in 9-month suggests that the $ 17 bln full-year target is credible;
  • SBP’s FX reserves fell by $ 5.5 bln since end-February, and the rupee has been on a roller coaster ride. In our view, this does not reflect economic fundamentals but ongoing political developments;
  • While the FM is keen to restart the EFF, prior conditions could be tough. The need to eliminate fuel subsidies, to increase power tariffs, steps required to rehabilitate loss-making SOEs, and the need to build FX reserves, will require unpopular steps.  With a large and unstable coalition, SS may opt for early elections and let the 3-month interim government do the heavy lifting;
  • IK held large and energetic rallies in Peshawar, Karachi, and Lahore, as his supporters ignored PTI’s poor economic performance while in power. IK’s narrative about the endemic corruption in Pakistan’s political dynasties, which have been allowed to stay in power because of Western (US) support, appears to have fired up his supporters;
  • While PTI wants early elections to be announced immediately, the ruling coalition parties are not singing from the same page. In our view, given the corrective steps required and the diverging interests of coalition partners, the SS government will call for early elections as soon as preparatory work for the next elections has been completed;
  • The war in Ukraine will drag on as Russia has changed its focus to Eastern Ukraine and taking control of Ukraine’s access to the Black Sea. As this conflict continues and more civilians are killed and displaced, the divide between the West and the East (Russia, China, India) will deepen.  This has repercussions for Pakistan, as both sides will want to know what side of the fence Pakistan would prefer to be in.
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March 22, 2022

  • The opposition tables a no-confidence (No-C) vote against the PM for 28th March;
  • IK has responded by warning that PTI will gather one million supporters in D-Chowk to impede turncoat PTI lawmakers and opposition MNAs from attending the No-C vote;
  • Both sides have approached the Supreme Court (SC) for clarification on defecting lawmakers, but the SC is unlikely to impede the constitutional system;
  • Although IK claims he has a surprise in store, it would appear the opposition has the numbers to end IK’s term as PM;
  • The timing, however, is awkward: on 28th February, IK announced a relief package to cut fuel prices by Rs 10/liter and power tariffs by Rs 5/unit, and keep these prices fixed till July 2022. Against the backdrop of the Russian invasion of Ukraine and the resulting spike in global commodity prices, the cost of this subsidy will surely derail the EFF.  Reversing the relief package will spike inflation and carry a heavy political cost;
  • In our view, the easiest path forward is for IK to call early elections in exchange for the withdrawal of the No-C vote, while the 3-month interim government would take the painful steps to bring Pakistan back on track with the EFF;
  • Looking at the economics, February’s current account deficit (CAD) at $ 545 mln was shockingly low. The abrupt narrowing in the absence of policy measures to contain imports in February, makes one question if this improvement is sustainable;
  • February’s oil import bill is lower than what was posted each month between Aug to Dec 2021, while auto and food imports have fallen sharply in February. This is likely to reverse itself in the next several months;
  • Telltale signs that the IMF is seeking a return to cautious policymaking can be seen in the recent weakness of the rupee;
  • SBP maintains the status quo on interest rates and supports PTI’s political narrative. However, it warns that the next MP decision could be ahead of schedule if “external” factors demand it.  We see rates hikes in the next few months;
  • Russia’s invasion is bogged down by Ukrainian resistance, as both sides have hardened their positions. Western sanctions against Russia have hammered its economy, but this does not appear to weaken Putin’s resolve.  Mainstream media (CNN, BBC, etc.) has adopted a one-sided narrative in the conflict, which will make a negotiated settlement more difficult;
  • NATO is wary of directly engaging Russian troops/jets, which means the invasion will drag on and the humanitarian cost (deaths and refugees) will continue to mount. The conflict will also keep commodity prices elevated, which means the EFF takes on greater imperative;
  • A number of prominent countries have refused to condemn Russia, which means Russia is not as isolated as the West would like. In our view, Russia (in collaboration with China) is trying to create an alternative currency clearing system that bypasses US restrictions on $ clearing.  In our view, this may be the most prominent repercussion of the war in Ukraine.
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February 24, 2022

  • $ 2.56 bln current account deficit (CAD) in January is a record high and has shocked the market. Compared to $ 1.8 bln in December 2021, this was primarily driven by a fall in both exports and remittances;
  • This makes the $ 13 bln CAD target for FY22 unachievable and will require tweaking the EFF targets. The IMF may concede that the sharp increase in oil prices is beyond the control of member countries, but it may not provide much leeway on other program parameters;
  • February 2022 IMF Staff Paper anchors Pakistan’s economic outlook:
    1. 6th Review covers the period till June 2021, which means performance targets for March and June 2022 are likely to change;
    2. The IMF projects inflation at 8.9% in FY22, but this is likely to be revised upwards;
    3. IMF has added 6 new Structural Benchmarks (SBs) to the EFF that must be met by June 2022. Two will be difficult: (1) shifting all SBP refinance schemes into a new DFI; and (2) parliamentary approval of a new state-owned enterprise (SOE) law.  We expect resistance from business elite and politicians;
    4. The IMF has given Pakistan 12 months to retain import margins and restrictions on forward cover till its BoP position stabilizes; &
    5. Unlike the government’s perspective that BoP pressures come from global commodity prices (especially oil), the IMF places most of the blame on strong import growth fueled by strong domestic demand. The latter can be traced to expansionary fiscal and monetary policies implemented during the Covid lockdown.
  • In view of the IMF’s tone, we expect SBP to increase interest rates in March 2022, despite an earlier signal that it would “pause” on further rate hikes;
  • With Brent crossing $ 105/b, further hikes in fuel prices are expected. The resulting public pain and anger will keep the PTI government on the defensive;
  • Large CADs since October 2021 have not been reflected in the rupee parity, but this is likely to change in the months ahead;
  • Our inflation projections for FY22 have been increased to 12.4% (average) and could go as high as 16% (YoY) in June 2022;
  • Pakistan has crested the 5th Covid wave, and it appears the Covid fear (globally) has receded significantly. Pakistan has done very well given the size of its population;
  • Opposition parties have a lot of ammunition to remove IK as Prime Minister, but given the difficult economic outlook, they would rather let PTI shoulder the blame than take ownership for the economy; &
  • Russia’s invasion of Ukraine did not surprise the world, but the mounting fatalities and uncertainty are shaking the global order. Sanctions have not deterred Putin, and his fiery words reveal that he is willing to step up the conflict rather than seek a settlement.  With the world split into the US and Sino-Russian camps, IK’s visit to Russia will reinforce the impression that Pakistan is aligned against US interests.  This is risky as Pakistan is dependent on the EFF, and the IMF is likely to play hardball.
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January 23, 2022

  • Two key Bills (mini-budget and SBP) are approved by the National Assembly, after a noisy and chaotic 7-hour session attended by the top leadership of all political parties;
  • This paves the way for the EFF, which should be a source of comfort for the economy;
  • PBS rebases its GDP data using 2015/16 as the base year. As a result, FY21’s 3.9% growth using the old base is upgraded to 5.4%, while the new base shows the growth at 5.6%.  We are not surprised by the upgrade, as the stimulus-based economic boost was concentrated in the large businesses;
  • December’s current account deficit (CAD) hits $ 1.93 bln, raising concern about the external deficit and what is required to bring this under control;
  • Oil, autos, and food imports are driving the CAD to unsustainable levels, as measures to pare down imports have not succeeded;
  • Exports perform well in December, but this will not be able to reverse the sharp increase in the external deficit. Pakistan’s BoP has become its most pressing policy challenge – again;
  • Except for lumpy inflows (IMF allocation and Saudi placement), SBP’s FX reserves continue to fall. We are surprised that SBP stabilized the rupee after 10th December even though the underlying deficit was still so large;
  • Pakistan is rushing to issue a $ 1 bln Sukuk even without the formal approval for the EFF – this could be driven by the persistent fall in FX reserves;
  • With elevated Brent crude prices, removal of GST exemptions, and rising utility rates, inflation will continue to increase well above SBP’s 9-11% range for FY22. Furthermore, the measures that will be taken as part of the Finance (Supplementary) Bill, will add to higher retail prices.  Opposition parties are using inflation to drum up public rage against the PTI government;
  • Prime Minister Imran Khan’s warning that he would be more disruptive outside the government, is a clear indication that there is growing pressure against his government, which may not complete its full term;
  • The fifth Covid wave has hit Pakistan hard, breaking records for the speed of transmission and daily infections. Fortunately, the less virulent Omicron variant has kept fatalities down and the government is not considering strict lockdowns but smart containment;
  • The Russia-NATO standoff could turn hot, while the drone/missile attacks on the UAE reveal that the détente with Iran is over.
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December 21, 2021

  • GoP moves on key prior actions like the mini-budget and the SBP Bill 2021, but details of the latter are not public;
  • There are rumors the IMF board meeting could be delayed as GoP has postponed a cabinet decision on the Finance Bill and the SBP Bill. While we think these will be approved (with some grandstanding in parliament), the delay will put pressure on SBP to manage market sentiments;
  • Media reports suggest that hard steps are being taken to impose a 17% GST on 140 items while reducing the discretionary power of senior customs officials. These are positive steps, but will carry a political cost (this will stoke inflation and reduce corruption);
  • SBP hikes rates by 100 bps and says it will pause in the near future. While the intention is to keep banks from pushing market rates any higher, commercial banks will react to inflation and the external deficit and are likely to keep pushing SBP;
  • The CAD in November is $ 1.9 bln, which is smaller than the market’s expectation. This is because PBS data shows imports at $ 7.9 bln, while SBP claims it was $ 6.4 bln – there is no clarification about this significant discrepancy;
  • SBP hints at a full year CAD of $ 13-14 bln in FY22 but does not specify the target. Even if the full year CAD is $ 13 bln, the external deficit will have to be brought down sharply in 2H-FY22.  SBP also revised its inflation projection to 9-11%;
  • Rising inflation (especially food inflation) has become the main policy concern, but little can be done to control it as retail fuel prices are expected to increase further;
  • Challenges continue to pile up: the rupee-dollar parity; the fall in FX reserves; OMO injections as SBP tightens domestic liquidity; $ debt servicing; the increase in fuel prices even if Brent crude remains soft; and the fall in worker remittances as international travel begins;
  • The import pressure from the monetary stimulus has been compounded by rising commodity prices (foods and fuels). While textile exports posted a record high in November 2021, this is not the case for net textile exports;
  • Afghanistan remains a challenge and there is no roadmap of what lies ahead;
  • IK skips President Biden’s Democracy Summit, which shows that Pakistan is aligned with China;
  • Economic pain and political uncertainty make this the most challenging period for PTI. Opposition parties do not appear keen to force a change in government, which could reflect their concern that managing the economy will cost them political capital.  The outlook for PTI in the 2023 elections is not good.
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November 20, 2021

  • After a month of uncertainty about the IMF program, a staff-level agreement has been reached with 2 key prior actions – parliamentary approval for the SBP Bill and the Finance Bill. The latter will translate into a mini-budget, which will focus on GoP’s taxation plan for FY22;
  • A min budget is required as the government has been double-minded about passing on the increase in global oil prices to retail consumers. Despite the sharp increase in fuel prices in the last two months, further increases are likely;
  • The SBP Bill has been politicized and there is a risk that it may not be passed. The revised Bill has not yet been released to the public;
  • October’s current account deficit (CAD) is $ 1.66 bln, which is higher than expected. The 4-month CAD of $ 5.1 bln cannot be sustained in the rest of FY22, which means the authorities will have to step up their efforts to reduce imports in the remaining part of the fiscal year.  We still await the IMF Staff Paper to know the size of the full-year CAD the authorities have agreed to;
  • Import data reveals that while non-oil imports have plateaued and could fall in the months ahead, oil and food imports will continue to trend up. This means monthly imports will not fall as sharply as the authorities hope for;
  • Furthermore, remittances have dipped in October, and if foreign travel starts with the easing of covid restrictions, this could add further pressure on the CAD;
  • SBP increased the cash reserve requirements (CRR) from 5 to 6% in an effort to reduce domestic liquidity. This is expected as a prelude to restarting the EFF, but since SBP has been injecting about Rs 2 trn short-term liquidity into the system, we expect the EFF to also focus on reducing the liquidity that SBP is injecting into the system;
  • With monthly data releases for inflation and the CAD, the stream of bad news is likely to continue. Not only could this impact the rupee (and business sentiments), but also generate public anger.  This will translate into political pressure against the PTI government;
  • Cooling relations with the US after the Taliban takeover of Afghanistan remains a source of concern. Pakistan’s global image has been further tainted by the negotiations between the government and banned groups like the TTP and TLP;
  • With Pakistan’s structural problems in the external sector once again in the limelight, we argue that the only way to break out of this impasse is to focus CPEC 2.0 on generating hard currency via a new set of exports or playing a transit corridor role for regional trade flows or saving hard currency via import substitution.
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October 22, 2021

  • The inconclusive IMF-Pakistan talks unhinge the FX and money markets. This is surprising as the sharp increase in fuel prices and reports that Pakistan had agreed to increase power and gas tariffs, were viewed as prior actions that often precede an agreement with the IMF;
  • The rupee continues to weaken (currently trading above 175/$), while the last T-bill auction failed as banks were unwilling to offer money to the government. Market sources claim that the market has already factored in a 100-125 bps increase in the discount rate;
  • No reason has been given for the “inconclusive” negotiations, as key policymakers remain silent about what happened in Washington D.C.;
  • The combined hike in fuel prices and the weakening rupee has stoked inflationary expectations. Our projections show that avg inflation could be as high as 13% in FY22, with food driving the momentum;
  • Realizing the anger this has unleashed, the government is now talking about subsidizing fuel for motorbikes and public transport. This will be very difficult to implement and reflects a degree of desperation in policymaking.  Unfortunately, the surge in food prices will continue;
  • The government has promised a cash subsidy for the poor, but details have not been disclosed;
  • The economic pain has unified the opposition parties, and this momentum will grow as food prices continue to push more people below the poverty line;
  • In our view, the main point of contention with the IMF would be the size of the external deficit in FY22. Even during the finance minister’s visit to D.C., he was quoted as saying that Pakistan would achieve 5% growth this year.  But high growth comes at a price – an elevated import bill and a larger current account deficit (CAD).  At a time of rising commodity prices (esp. food and energy), this is a luxury the IMF would perhaps not allow for.  We argue that Pakistan needs a CAD of $ 13 bln (or more) to achieve high growth;
  • Looking at key imports (oil, food, and auto parts), policy interventions to reign in imports may not succeed, which means the rupee will continue to weaken. September’s CAD of $ 1.1 bln needs to be brought down in the remaining part of FY22;
  • The market is unlikely to settle down without a firm start date for the EFF. This puts a great deal of pressure on policymakers;
  • Aside from the economy, Covid cases are falling and restrictions on public gatherings have eased significantly. The positivity rate is at the lowest level since the pandemic started in early 2020;
  • The lack of sovereign recognition of the Taliban government has pushed Afghanistan to the global backburner. However, the growing humanitarian crisis – which will get worse in the winter – is putting pressure on humanitarian agencies and OECD countries.
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