Presentations

• GoP appears to have come to an understanding with the IMF, whereby Pakistan will come close to the IMF’s revenue targets for FY22, but will not increase power tariffs;
• The FY22 federal budget expected on 11^th June should provide a handle on the compromise that has been agreed upon;
• SBP and MoF initially reject the National Accounts Committee’s 3.94% growth projection for FY21, but backtrack after IK Tweeted his satisfaction with this better-than-expected outcome;
• Since December 2020, we have argued that Pakistan’s economic growth would be 3-4 %, which was much higher than official projections. We based this on growing non-oil imports, strong LSM growth, the uptake on TERF, and how a strong rupee improved business confidence;
• April’s YoY inflation hits 11.1%, which is awkward for SBP. The central bank is also on the defensive because of the FM’s criticism about hiking interest rates in 2019; the Supreme Court petition against SBP’s top management; & the controversy about the amended SBP Act.  In view of this, we do not expect SBP to raise interest rates in July (and beyond);
• The CA deficit in April is $ 200 mln, which is higher than we expected. The 10-month CA surplus is now $ 773 mln, and we predict a full-year surplus of $ 630 mln.  This improvement is driven by remittances, which have posted an inflow of $ 24.2 bln in 10 months;
• This positive outcome does not mean Pakistan’s external sector problems have been solved. External debt payments in the year ahead still exceed SBP’s liquid FX reserves, and Pakistan is rolling over its ST dollar debts;
• We make a strong argument that Pakistan needs to focus on import substitution. The IMF’s BoP projections show no structural improvement in the external sector but expect a growing CA deficit to be financed by FDI and fickle portfolio inflows.  By containing imports (as Pakistan has done between FY18 to FY20), the country can stop borrowing or rolling over its debt, and it can grow its FX reserves and manage the rupee in a predictable manner;
• Pakistan appears to have crested the 3^rd pandemic wave, despite a brief spike after Eid. However, given the devastation caused by the Indian variant, and the similarity between India and Pakistan, we urge caution and support the government’s proactive steps to reduce social interaction;
• Israel’s brutal attack on Gaza City ended with a ceasefire, but the underlying problems have not been resolved. While Israel has taken such actions in the past, this time may be different because of the impact of social media and the growing frustration amongst Palestinians towards the Palestinian Authority.  It also exposes the inadequacy of the Abraham Accords and raises concern that if Saudi and the UAE ignore the plight of the Palestinian cause, this will split the Arab world.  This could create complications for Pakistan as it relies on the GCC for emergency loans and remittances.

• After a series of changes in the finance team, a new team under the stewardship of Shaukat Tarin has been created. After making statements against the IMF program, the new FM has become silent;
• We interpret this as a sign that the GoP and the IMF are discussing the final shape of the EFF, which will be unveiled in the forthcoming federal budget for FY22;
• The IMF releases its Staff Paper on April 8^th. Program details show a laser focus on the circular debt problem, and the need for a multiyear tax reform agenda to remove tax concessions and exemptions;
• Rising FBR targets from FY22 onwards, highlights Pakistan’s weak tax machinery. Furthermore, growing targets for surcharge revenues means the government will not be able to protect consumers from rising global oil prices;
• The IMF’s focus on the autonomy of key regulators (Ogra, Nepra, SBP) seeks to reduce the government’s role in setting key prices. This means the setting of power tariffs, fuel prices, and the rupee-dollar parity, will not involve the government;
• This may explain the change in the government’s narrative about the IMF program. We argue that both sides will stand firm, which means the ongoing negotiations will not be easy;
• External sector data has been revised, and the CA deficit in FY20 has increased from $ 2.97 bln to $ 4.45 bln. Also, the 9-m CA surplus in FY21 has increased to $ 959 mln, after posting a deficit of $ 47 mln in March 2021;
• As a result, we have changed our full-year FY21 projection of the CA deficit to $ 0;
• To sustain growth of 4-5% in the next five years, the IMF projects the CA deficit to increase from $ 5.4 bln in FY22 to $ 11.5 bln in FY26. This gap is to be financed by private foreign investors (e.g., equity inflows, carry trades, and Pakistani banks borrowing from abroad).  If these inflows do not materialize, the CA will remain a challenge.  Using private inflows to finance the CA deficit is inherently risky, as shown by what Turkey is currently experiencing;
• Inflationary expectations are being managed by controlling fuel prices and power tariffs, and by keeping the rupee strong. These measures have succeeded, but will not be allowed in the IMF program;
• The 3^rd wave of Covid-19 is alarming but is not trending up. The NCOC has been proactive to shut down schools, markets, restaurants and has told offices to limit people and working hours.  The crisis in India should be an effective cautionary tale to ensure that Pakistanis take the pandemic seriously;
• President Biden’s decision to unconditionally withdraw from Afghanistan, has raised hope and concern in Pakistan. Some people feel this will strengthen Pakistan’s hand in dealing with the Biden Administration (with implications for our discussion with the IMF), but others think it leaves Pakistan isolated and vulnerable.  We think Biden will argue that what happens in Afghanistan is not the sole responsibility of the US, and his government will not take ownership.  This means Pakistan’s leverage will be limited.

• SBP’s Act has been amended to meet IMF conditions to resume the Extended Fund Facility (EFF);
• The salient features are:
  • Controlling inflation will be the primary goal, and SBP’s development agenda will only be of tertiary importance;
  • The federal government will not be allowed to borrow from SBP;
  • The Ministry of Finance will have no say in determining interest rates or how the rupee is managed;
  • The Secretary Finance will no longer be a member of SBP’s board;
  • SBP will halt all quasi-fiscal operations on the behalf of the government, but it can continue its refinance schemes to target underserved sectors (not specified); &
  • The allocation of SBP’s profits will be solely determined by SBP’s board, which will prioritize building SBP’s paid-up capital.
• While the thrust of these changes is positive, we think this will not serve the country well. More specifically, crowding out of the private sector will not be addressed; refinance schemes will be subservient to controlling inflation (via capping reserve money growth), and banks will further shy away from SME financing.  Banks will focus on elite clients like the GoP and blue-chip corporates;
• This flavor of autonomy (also seen in Nepra’s mandate) seeks to pass on the cost (to the average Pakistani) of not addressing fundamental issues like insufficient tax revenues; a growing circular debt; and loss-making SOEs;
• This IMF program entails a heavy political cost on the PTI government, as the coalition of opposition parties could use the economic hardship to attack PTI;
• The current account (CA) deficit in February was only $ 50 mln, which is lower than we had anticipated. Nevertheless, the $ 881 mln CA surplus posted in the eight months of FY21, gives Pakistan enough room to grow the economy;
• The anticipated rise in YoY inflation will be awkward for SBP after its newly minted mandate to focus on controlling inflation;
• Remittances post the 9^th consecutive month of $ 2bln + inflows, which is likely to continue. However, inflows from the UAE and Saudi Arabia have dipped in the past two months, which is a source of concern;
• The autonomy of SBP and Nepra (& we expect something similar for Ogra) may reduce the government’s control on regulators, but it does not signal a tense relationship in the future. In our view, regulators will be expected to behave “responsibly” despite their “autonomy”.

• January’s current account (CA) deficit was smaller than anticipated (at $ 229 mln).  However, we still expect the remaining months of FY21 to post deficits as imports will remain elevated.  With a $ 912 mln balance of payments (BoP) surplus in Jul-Jan 2021, Pakistan has the room to grow imports without stressing it BoP.  We expect Pakistan’s CA deficit in FY21 to be around $ 2 bln;
• IMF announces that the EFF will start in April 2021, but only $ 500 mln will be released for the 2^nd to the 5^th quarterly reviews.  This means that Pakistan was in the EFF during 2020 and the $ 1.4 bln emergency assistance provided in April 2020, has been internalized in the EFF;
• This reaffirms our view that Pakistan’s economy has done well during the pandemic; more specifically: (1) the smooth exit of carry trades; (2) travel restrictions have boosted remittances and kept monthly inflows above $ 2 bln in the past 8 months; (3) the global focus on relief and stimulus allowed the authorities to embark on TERF; (4) the fall in oil prices helped Pakistan’s BoP; & (5) if the program ends as scheduled in Sept 2022, this means the next general elections will take place after the IMF program ends.
• The composition of monthly imports strongly suggests that Pakistan is experiencing a growth phase.  In the past two months, non-oil and machinery imports are at record highs, while the import of CKD kits (to assemble motor vehicles) is trending up sharply;
• Exports have bounced back sharply after the lockdown, but we are concerned that this may reverse when other textile exporters (e.g., India and Bangladesh) come back online;
• We are surprised that YoY inflation edged down in January, especially after 4 consecutive increases in retail fuel prices and the hike in power tariffs.  This has lowered our inflation projection to 9.6% in FY21 but expect a rise in inflation in the months ahead because of the base effect.  However, we do not see SBP increasing interest rates in the period ahead;
• We maintain our growth projection of 3-4 % for FY21, which is far higher than the IMF’s 1½ %, and even SBP’s range of 1½ – 2½ %.  We cannot explain why the IMF is so pessimistic, since business confidence is high, and imports will remain strong in 2021.  However, the growth momentum will have to be pulled back when BoP pressures begin to manifest.

• The streak of monthly current account surpluses ends in December, with a deficit of $ 662 mln. The reversal from a surplus of $ 513 mln in November has changed our full-year BoP projections;
• This turnaround is driven by a $ 940 mln increase in imports in December, which can be traced to food imports (to contain food inflation) and underlying economic activity in construction and textiles;
• This supports our elevated growth projection of 3-4% in FY21, but it does so at the expense of the BoP comfort so far;
• Monthly remittances were strong in December ($ 2.4 bln), and should remain buoyant while travel restrictions remain in place;
• The IMF’s full-year BoP projection will give us a better handle on currency stability and the accumulation of reserves by end-FY21. As things stand, the rupee should be stable till March and then experience some flexibility as the country transitions into the IMF program;
• We expect the IMF negotiations to focus on familiar issues like raising power tariffs, containing the circular debt, increasing FBR revenues, and pushing for the autonomy of SBP and Nepra. We expect the EFF to restart in April with binding targets for June 2021;
• With the recent power tariff and retail fuel price increases, we have raised our inflation projections to the upper end of the 10-11% range. The base effect will exaggerate YoY inflation in Q1-2021;
• This may put some pressure on SBP to increase interest rates in March, but it will only be a token;
• While Western countries have rolled-out mass vaccination programs, daily infections, deaths, and hospitalization are at record levels in the US and UK. Hence, the anticipated sense of relief from the vaccine has not materialized;
• In Pakistan, on the other hand, the second wave appears to have peaked. With the number of currently infected under 35,000, we have a lot to be grateful for.  Also, vaccinations could start by March, but no details about the roll-out are available;
• Tensions between the PDM and the PTI government have escalated in recent weeks, but this will not destabilize the government or have any impact on Pakistan’s economy;
• Joe Biden becomes president with a peaceful transition of power. President Trump experienced a tragic end to his presidency, after his stunning political blunder to incite his supporters to storm the US Capitol.  Trump has now been impeached twice, has lost his standing in the Republican Party, and has alienated his support base.
• We expect better relations with the Biden administration and will focus on how this White House handles Saudi Arabia, Iran, and India.

• The fifth month of a current account surplus is a source of comfort for Pakistan.  The $ 1.64 bln surplus posted so far in FY21, suggests that Pakistan may be able to post a “balanced” balance of payment this fiscal year;
• Remittances remain strong, posting a 27% increase over the same period in FY20.  This means the tightening of dollar leakages linked to travel restrictions has dominated the possible loss of jobs by Pakistanis working in the GCC;
• The second wave of Covid-19 infections is alarming, but the recent trend suggests that the wave has crested.  There is no vaccination rollout plan yet, but we expect this to be announced in early 2021;
• China’s economy has recovered much faster from the pandemic compared to the West.  While vaccinations are being rolled out in Western countries, the nature of their economic recovery remains uncertain;
• Media reports on the negotiations with the IMF, state that fiscal measures, power tariffs rates, and the elimination of exemptions remain contentious.  Talks will commence in 2021;
• Food inflation remains a policy priority, and media reports claim that Pakistan has managed to delay the imposition of GST on food items.  Nevertheless, our projections suggest that food inflation will remain elevated throughout FY21;
• As fiscal measures are implemented and retail fuel prices adjust to rising global prices, we have increased our inflation projection to 10-11% in FY21;
• Monthly trade flows show a fall in April and May 2020 (as the lockdown impacted commercial activities and logistics) but have since bounced back.  Non-oil imports are now above pre-pandemic levels, but exports are struggling;
• With a comfortable BoP, we think the authorities will keep the rupee stable for the next few months to sustain the improvement in business sentiments.  This means the rupee could end FY21 around 168/$;
• The pickup in construction activity has increased the price of cement and steel.  Given the role construction plays in supporting other sectors of the economy, we have upgraded our growth estimate to 3-4% in FY21, which is much higher than the IMF’s 1% growth projection;
• Private sector credit disbursement remains low as banks focus on lending to the government.  We reiterate our concern that Pakistan’s banking system will become more shallow as SMEs, Agri, and micro-enterprises rely on the non-bank financial system, which relies on cash and supports the bulk of employment in the country.  Efforts to increase tax revenue as the economy becomes more undocumented will only incentivize the informal economy;
• The political scare from a unified opposition “long march” has largely dissipated, as cracks in the opposition coalition are becoming more pronounced.

• The current account surplus for the fourth consecutive month is surprising, and very good news as Pakistan deals with the on-going pandemic;
• SBP’s Annual Report for FY20 is disappointing. It doesn’t acknowledge the uncertainty that currently exists, and parts of the report are self-serving. The fact that SBP is pinning its hope on the positive response to its subsidized credit scheme (Temporary Economic Refinance Facility – TERF) is strange – it is almost as if the central bank is trying to paint an optimistic picture;
• Food inflation remains a challenge, and SBP has increased its FY21inflation projection to 7-9%;
• An IMF mission is expected to visit in the weeks ahead. This means program conditions are now being implemented, which could explain the surprise weakening of the rupee since end-September. However, with Christmas approaching and the pandemic raging in the US, negotiations could drag into 2021;
• Program details should begin to leak out, but we know that the autonomy of Nepra and SBP, power tariff increases, and additional tax revenues will be the focus. SBP’s projection for the twin deficit in FY21 shows a fiscal gap of 7% of GDP and an external deficit of 1½%, which is pretty much business-as-usual (this can also be seen in SBP’s projections for imports, exports, and remittances in FY21);
• Despite a current account surplus of $ 1.16 bln so far in FY21, SBP’s FX reserves have fallen by $ 205 mln in this period. This shows that debt repayments will make it difficult to build reserves, which means there will be pressure on the external sector (despite the comfortable CA position). However, details will only be available when the IMF releases its next Staff Paper;
• Inflation will remain elevated in FY21, but SBP may shy away from increasing interest rates too soon. Food, utilities, and transportation costs will drive inflation, and these supply-side factors could justify SBP staying neutral;
• Covid-19 cases are rising in Pakistan and the second wave is alarming. However, the numbers are still manageable, and the government has been very proactive in its management. We do not see an across-the-board lockdown in the country;
• However, the global impact of the pandemic has been worse than expected, and even with the good news about successful vaccines, the US and EU are still struggling. It will take some time before the global economy is able to recover to pre-pandemic levels;
• Joe Biden wins the US presidency, but President Trump still refuses to accept the result. Democrats have not done as well as people had hoped for, and with the Senate likely to remain under Republican control, Biden will not have a productive or easy presidency. The US is deeply divided, which means the American Empire will continue to decline as Americans themselves reveal that they are not interested in global affairs.

• Current account surplus in 1Q-FY21 is good news, but it goes against the IMF’s narrative that the MENA region (which includes Pakistan) could take as much as 5 years to return to normal;
• The IMF projects Pakistan’s growth at only 1% in FY21 and a CA deficit of 2½% of GDP, while the GoP predicts growth of 2.1% and a CA deficit of 1½% of GDP. We are closer to the government’s assessment since Pakistan has managed to contain the pandemic and is off to a good start with the BoP;
• Negotiations to restart the EFF appear to be stuck on how the authorities will manage the ballooning circular debt and raise tax revenues. With the government battling high food inflation and a coordinated opposition that seeks to unseat the PTI government, the appetite for hard measures is clearly lacking;
• The PM has been warning citizens about the risk of a second wave of Covid-19. We argue that this is designed to remind people to follow SoPs, but there is little risk that Pakistan could return to shutting down the economy. Infections are rising but the quantum is still very much under control;
• Remittances remain strong and October is likely to be supportive. Even assuming that remittances falls and exports remain sluggish in FY21, we do not see much pressure on the rupee.  However, we see some depreciation at quarter ends to ensure that the rupee adjusts for inflation and interest rate differentials with the US;
• Despite the positive start for Pakistan’s BoP, SBP’s FX reserves have not trended up. This shows that debt repayments are so heavy that even with balanced $ flows in the current account, the central bank will struggle to build its reserves – this will be a critical metric in the EFF (when it starts);
• Even with a more controlled currency, the steps required to control the circular debt and raise tax revenues will stoke inflation in 2021. Our projections show that average inflation this year could be 10% with a rising YoY trend in the second half of FY21;
• In terms of Pakistan’s outlook, a great deal hinges on the US elections. If President Trump loses – which now appears likely – Pakistan should see several positives: tensions in the ME should ease; Kashmir should gain global attention; and a coordinated effort to fight Covid-19 should see a quicker global recovery;
• Since Pakistan has managed to avoid the worse of the pandemic, we do not see much leeway from the IMF when the EFF restarts. With little appetite to tackle the stubborn economic problems, Pakistan will continue to muddle through 2021, pretty much like it has over the past several years.

This is a presentation that was prepared for HBL as part of its client event HBL Global Markets Outlook 2020, which took place as a webinar on September 29th, 2020.  The focus is specifically on Pakistan’s economy, but unlike our monthly presentations there is more context on: how we got to where we are; the repercussions of this journey; what to look out for in the months ahead; and regional and geopolitical events that could impact Pakistan and its economy.

• Record monsoon rains across the country, disrupt social and commercial activities and trigger public anger against local authorities;
• Economic impact of the rains has not been quantified yet, and experts are predicting heavier monsoon rains in the years ahead;
• Covid-19 numbers continue to impress and surprise. However, a recent surge is taking hold that can be traced to greater social interaction (weddings, restaurants, etc.) and the opening of schools;
• Still no indication when the EFF will restart, which means the BoP outlook for FY21 is still uncertain – as is the rupee-dollar parity;
• Pakistan’s BoP position continues to improve, with the second consecutive monthly current account surplus. July & August’s external balance posted a surplus of $ 805 mln, against a deficit of $ 1.2 bln in the same period last year.  Despite the comfortable BoP position, the outlook for rupee remains unclear;
• Outflows in the financial account in FY21 suggest that net debt payments (fresh loans less repayments) could be more important than the above-the-line current account in determining how SBP behaves;
• No change in interest rates was largely anticipated. Given the inflation outlook in FY21, we think this is the end of the monetary easing phase.  We expect fiscal consolidation measures when the EFF restarts;
• SBP Governor states that real growth this year would be around 2%, while the external deficit should remain at 2% of GDP. This means the CA deficit could be in the range of $ 4-5 bln this year, which gives some space to increase imports and revive growth.  However, there is no indication of a growth phase;
• July’s revival in manufacturing is concentrated in cement, iron/steel and pharma, but consumer spending on autos and household electronics remains weak;
• Compared to peers and the developed world, Pakistan has not been as adversely impacted by the pandemic;
• In our view, developments in the Middle East, the outcome of the US elections and the global pandemic will influence Pakistan’s outlook. Remittances are vulnerable; exports depend on the global recovery and changing dynamics in the Middle East will test Pakistan’s foreign policy standing with friends and allies.  Pakistan’s economic vulnerability will weaken its role in regional developments.