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.
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 3rd 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 2nd 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 2nd tranche on Jan 11th, which is deposited on Jan 17th;
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 8th
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 8th;
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 2nd 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 8th 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.
