Pakistan’s Covid-19 numbers continue to impress and have now captured global media attention;
The country has slipped to 16th (of the worst impacted countries) from 12th a month ago. As of 23rd August, Pakistan has 10,118 active cases, against India’s 710,621 and Bangladesh’s 111,566;
While people are less anxious about the pandemic and the government has opened up larger segments of the economy, success with containing the virus may not translate into a rapid economic recovery;
We argue that the authorities want to ensure that the gains in the external sector are not jeopardized, since the global economy is still struggling and securing fresh loans to finance the external deficit will be more difficult in FY21;
The improvement in the external sector (July posted a CA surplus of $ 424 mln) has not given much comfort to the rupee, which is often used to trigger investment and domestic growth. Given Pakistan’s acute dependence on imports, the authorities appear to prioritize caution over economic recovery;
This level of caution is understandable. We show that the recent increase in remittances is coming from two countries (Saudi and the UAE), and argue that this can be traced to the sharp curtailment in air travel. With limited cash carried by incoming workers, the abrupt end to Umrah and Hajj travel and a sharp fall in khapia activity, Hundi balances that would have been used for these purposes (in the GCC), are now being routed into the country. As travel returns to normal, we expect monthly remittances to fall;
In gauging the outlook, one must realize that the world is still grapping with the pandemic. Global demand for Pakistan’s exports and inward remittances are vulnerable. We also think geopolitical dynamics could play out in the months ahead as the US gears up for a bruising election in November. Pakistan should therefore carefully manage its interests against the competing demands of Middle Eastern countries;
On a final note, the PTI’s 2-year report card shows that policy focus has been on averting economic crises rather than solving them.
The rate of daily infections has fallen consistently since mid-June, and Pakistan appears to have peaked much earlier than projected;
As of 22nd July, there were only 50, 307 active cases, which indicates the falling number of daily infections and the fact that most infected people make a full recovery;
There are concerns of a resurgence during Eid and Moharram in August, but we think the authorities should be able to manage social gathering for public safety reasons;
All this good news, however, does not translate into a better outlook for the economy. Although markets have been open since late May, retail volumes are down and demand is cautious. Unfortunately, the fact that most commercial entities in the country are undocumented, creates two disadvantages for the recovery: (1) many SMEs are out of policy reach; and (2) the adverse impact on the economy is hard to gauge as accurate information is not available;
Covid-19 has changed human behavior across the world, and a return to economic normality is not likely until a universal vaccination program has been successfully implemented;
The macro economy has held out well with stable FX reserves, a small external deficit and falling inflation (SBP’s reserves are above $12 bln; the current account deficit is $3 bln against a target of $ 6.6 bln; and inflation closed the year on target at 11%);
However, the recent pressure on the rupee is surprising and there are concerns that record high remittances in FY20 ($ 23 bln) may experience a sharp fall because of the global pandemic;
Secondary market rates have softened after the surprise 100 bps rate cut on 25th June, but we do not think SBP will cut interest rates next month. With the country re-entering the EFF soon and BoP conditions still uncertain in FY21, the authorities may want to be cautious to protect the gains on the external sector;
Globally, the war against Covid-19 is not going very well with the US failing spectacularly to contain the spread of the virus. Europe is opening up very cautiously and East Asia is experiencing a second wave. Without a complete victory, the global economy cannot recover, which means Pakistan’s economy will also remain in limbo;
We argue that if the “undocumented majority” is ignored by policymakers, the resulting frustration could trigger social unrest;
The pandemic should force policymakers to push for greater documentation, not just to help those in need but also to better understand how Pakistan’s retail sector operates. That this has not happened, is disappointing.
The pace of infections and deaths has accelerated since Eid (24th May), which coincided with the opening up of the economy;
In response, the government has imposed smart lockdowns, which have targeted specific areas where infections are rising rapidly;
We argue that containing the pandemic should have greater priority over restarting the economy. This is not to understate the importance of restarting the economy, but the logic that if the pandemic continues to spread, people will stop interacting and the economy will not be able to sustain livelihoods;
The demand destruction is concentrated in non-essentials and luxury goods/services. We argue that demand revival will be slow and also uneven – again luxury goods will be the last to recover;
Hence, many firms are facing insolvency that could result in structural unemployment. This will not be a one-off event, but a gradual process;
SBP has launched several schemes to help struggling firms. They all focus on refinancing, which means liquidity support. This may allow firms to better manage their cashflows, but if the underlying demand does not pick up, refinancing will not help businesses survive;
Credit guarantees are needed to ensure that banks keep lending, and equity injections should be considered to improve the solvency of firms;
The federal budget for FY21 is not credible, but it signals that the IMF’s stabilization program should restart in July. In our view, Pakistan’s macro economy has held out quite well against the pandemic and is now better placed to handle external shocks. The EFF should be viewed as an insurance policy against the pandemic;
Pakistan’s BoP continues to surprise, and posted a $ 13 mln surplus in May 2020. At its current trajectory, the external deficit could be as low as $ 4 bln for the full year compared to the target of $ 6.6 bln. While this reflects the acute slowdown in the economy, as a time of global uncertainty, this is a positive;
Inflation continues to fall and should be at the lower end of the projected level at the start of FY20. SBP surprised the market by cutting rates by 100 bps (25th May), which suggests that this is the baseline for FY21 – however, it will do little to increase credit disbursement or revive the economy;
At the global level, we are troubled by the lack of credible information about the pandemic, which will only increase uncertainty;
Our main concern is the limited scope of the bailout packages in Pakistan. This is because SMEs are the main source of urban employment, and most of these firms are undocumented and therefore outside the reach of the government. Since the demand destruction has hit all commercial entities (documented and undocumented), Pakistan will struggle to recover compared to other countries with more documented economies.
Till May 22nd, Pakistan’s Covid-19 numbers are contained, but the recent trend is worrying;
GoP has stepped up with material support for the unemployed, but hospital capacity does not appear to be given priority. We argue that if people feel hospital care is insufficient (or substandard), they will not engage in commercial activity if they can avoid it;
Rising trend of daily infections and deaths is linear so far, but even this trend could overwhelm Pakistan’s healthcare capacity;
If social distancing and mask-wearing are not self-imposed, Pakistan may not experience a peak as seen in the West;
IMF’s rapid financing and commitments from other IFIs should allow SBP to manage the FX market;
However, the 160-161/$ range is not likely to last as it reflects subdued commercial activity during the month of Ramzan. Having said this, Pakistan’s BoP in April has been surprisingly supportive despite a full month lockdown in the country and overseas;
The bulk of carry trades have exited Pakistan without stressing the FX market (we see this as a positive development of the pandemic);
The 100-bps cut in interest rates should not result in further $ outflows, but will not attract fresh dollars;
With mutual consent, the Extended Fund Facility appears to be suspended. We argue that the IMF is working with GoP on the FY21 budget, which suggests that the EFF will commence in July 2020;
The current account deficit in April was $ 572 mln, which is good news given the global disruption created by the pandemic. The fact that remittances in the month were 1.8 bln, is surprising given the acute economic slowdown in the GCC and US/UK. We argue that the danger of a structural fall in remittances is still a very real threat;
The fiscal deficit in the first 3 quarters of FY20 was Rs 1.7 trn, which is less than the Rs 2 trn posted last year. This is largely because of high SBP profits and lower spending by provinces. Despite this narrowing, analysts think the full year deficit could exceed 9% of GDP; with the Coronavirus spreading in Pakistan, we do not expect much austerity in the remaining months of FY20;
With a stable rupee and a sharp cut in retail fuel prices, inflation will continue to trend down and end the year at below the range stated by both the IMF and SBP;
Since Pakistan has not been as adversely impacted as many other countries, some complacency has set in. The post-Eid period will be critical to see how the authorities open the market and whether there is a spike in infections as a result;
We reiterate our view that Pakistan is likely to experience a lockdown-relax-lockdown cycle, which is perhaps the only way forward. We also feel the pandemic will be in play for more than a year;
We conclude by urging greater focus on healthcare facilities and more clarity about how the authorities intend to open the markets. We also warn that demand conditions may not return to pre-pandemic levels till a global vaccination is implemented. Till then, if Pakistan can contain the number of infections, develop adequate ICU units, and keep the economy moving, it will have done very well for itself.
With the pandemic still playing out, economic projections are, at best, only guesses. Also, comparing Pakistan’s current trajectory to the pre-pandemic scenario is pointless;
This is a waiting game. The objective is to minimize the social, mental and economic dislocation until a global vaccine is discovered, manufactured and administered;
Community & religious leaders have forced the federal government to ease the nationwide lockdown for the holy month. They have agreed to self-regulate according to a 20-point safety protocol;
This is like a community decision to adopt herd immunity. This is risky as infections/deaths will surely increase in the weeks ahead, which means selective lockdowns could follow. This lockdown-relax-lockdown cycle has been discussed as perhaps the most effective way to find a balance between lives and livelihoods;
The EFF will move to the back-burner, as $ 1.4 bln emergency IMF funding should help calm the FX market. However, the IMF will continue to focus on the circular debt and SBP’s autonomy;
The pandemic’s impact has been particularly hard on the GCC. Oil prices have collapsed, and the region’s non-oil economic model has suddenly failed; we also think travel/tourism and oil demand may never recover to pre-pandemic levels;
The authorities need to account for a structural fall in remittances, which means the next few months will be challenging
Pakistan’s BoP is still comfortable. The pandemic has not impacted March’s trade flows (the initial period of the global lockdown, which suggests that past momentum carried things forward), but it has resulted in a $ 1.8 bln outflow of portfolio investment. This means that April’s BoP would be more indicative of the impact of the pandemic;
Currency in circulation has increased sharply in the past month. We also think the three interest rate cuts (cumulative 425 bps fall) will not have much impact on monetary dynamics and underlying economic activity;
Inflation will continue to edge down, but could settle at a higher level than we initially projected. This is driven by our assumption that the rupee will weaken in the months ahead;
Pakistan faces four immediate challenges: (1) how the spike in infections is managed during Ramzan; (2) the quantum of demand destruction; (3) managing the rupee with disrupted dollar flows; and (4) absorbing the vast number of blue-collar workers from the GCC who are being repatriated to the country;
But the pandemic also creates opportunities: (1) renegotiate the IPP contracts to secure a structural solution to the circular debt problem; (2) the federal government should work closely with local governments and Bazaar Traders to look out for the welfare of local communities; (3) use the food distribution and cash awards to improve the country’s database; and (4) with the likely fall in monthly remittances, the government should move aggressively towards import substitution.
In two weeks, the world has changed. In our February presentation, we had not mentioned coronavirus, the pandemic now dominates the narrative;
This is bigger than the Great Recession of 2008, and since it impacts everyone, the social and mental anxiety is perhaps unprecedented;
PSX is down 25% in a month, but global markets have been impacted more. The G-7 will certainly go into a severe recession, as will Asia and global supply chains;
The economic impact (in Pakistan and globally) is most severe on the middle class and daily wagers. Also, there is a direct impact on service sector jobs, which means social isolation (whether self-imposed or a policy of lockdown) is exacerbated by economic anxieties;
Pakistan will be hard hit, but the turnaround because of the pandemic has not been as severe. The number of cases so far is manageable (given the size of the country), but will rise and eventually overwhelm the country’s health infrastructure (as everywhere in the world);
With the virus-driven price war between Russia and Saudi Arabia, oil prices have collapsed and are likely to stay soft in 2020. This means PoL prices will be cut, which will accelerate the fall in inflation. This will put more pressure on SBP to cut interest rates in May 2020;
Carry trades and SBP’s reserves have been impacted, but till March 13th the impact has been low. We expect this to worsen in the weeks ahead. The rupee is also under pressure as foreigners pull out their money;
In this global pandemic, the IMF stabilization program should become easier. We will wait for the Staff Paper, expected in early April, to get a better handle on what happens next;
The 75 bps cut in interest rates on March 18th was deemed to be insufficient. We expect a 100-150 bps cut in May 2020;
BoP continues to improves driven primarily by imports – this will be supported by the fall in oil prices. However, we list concerns about exports, and more specifically, remittances from the GCC. The latter will be hard hit by the outlook for oil prices and the sharp fall in tourism;
We expect pressure on the rupee as portfolio outflows continue. However, with rate cuts and the global uncertainty, we expect SBP to manage the rupee to ensure that it doesn’t become too volatile (or lose too much value);
The incessant media coverage of coronavirus is necessary, as social behavior is a key factor in the spread of this pandemic. The OECD will be economically devastated, as will Asia and global supply chains;
Pakistan will be hit hard, but the economic impact is likely to be worse than the social/mental stress created by the pandemic – the latter should not be understated. Pakistani society is family and community based, and while the state’s social safety net leaves a lot to be desired, the former is a strong asset at times like this.
Inconclusive IMF discussions deflate market sentiments, but the EFF is not under threat. Contentious issues are the revenue shortfall and the persisting growth of the circular debt;
The IMF wanted a mini-budget to generate additional taxes and to increase utility rates to curb the circular debt. However, GoP argued that with food inflation at near record highs, such steps could destabilize the PTI government;
In the past month, expectations of a growth phase have swiftly ended. With the government struggling to manage food costs, it is on the defensive and the IMF mission has added to the sense of gravity;
Steps to bring down food prices and the fact that YoY food inflation touched 20% last month, suggests a sharp fall in food inflation in the coming months. This will pull down headline inflation, and add further pressure on SBP to cut the policy rate;
While we acknowledge that the inflation angle could justify SBP holding rates at current levels, we think the political pressure could tip SBP’s hand in March 2020;
Carry trades continue to grow and have reached $ 3.2 bln as of Feb 19th. Media and the Senate have taken a strong interest in these dollar inflows (mostly negative), which means SBP will remain under pressure to ensure that these funds are carefully monitored, especially in terms of how the authorities use the carry trades;
In our view, FBR revenues could get a boost if imports increase in the remaining part of FY20. With FX reserves above the IMF’s end-June 2020 target, it may be tempting for SBP/MoF to allow for an increase in imports. However, this is an unwise use of hot money;
The IMF Staff Paper is expected in the next 2 or 3 weeks, and will be critical to better understand Pakistan’s economic outlook. In our view, the IMF should revise its BoP projections for FY20 and increase SBP’s FX reserve target to cover at least 3 months of imports. This means the net international reserve (NIR) target for end-March and end-June will increase;
Our book review of McCartney and Zaidi’s 2019 book on Pakistan’s political economy, argues that a fresh assessment is necessary if one wants to understand why Pakistan has failed to reform its economy in the past three decades. We think the narrative on Pakistan’s economy must change to achieve real economic reforms.
The IMF Staff Report released in December 2019, conveys a more somber outlook than what the market expected. While the IMF is impressed (and surprised) by the narrowing current account deficit, it raises concerns about the fiscal side;
Although Pakistan fell short of the Q1-FY20 revenue target (albeit an indicative target) by Rs 107 bln, the impressive performance was driven by non-tax revenues. The report also highlights how the bulk of taxes collected in Pakistan happens at the import stage;
This reveals the lack of documentation of Pakistan’s economy. While all custom revenues are collected at the import stage, the report shows that 15% of direct taxes and 58% of sales tax were also collected at the ports in Q1-FY20;
With the EFF projecting FBR to collect over Rs 3 trn in 2H-FY20, we question whether GoP has a plan to generate this amount, or whether a revenue focused mini-budget is likely;
In reading the Staff Report, structural reforms appear to have been side-lined as the authorities are compelled to tackle the hemorrhaging by increasing utility rates, instead of fixing the underlying problem;
Despite the sharp narrowing of the external deficit (from $ 8.6 bln in 1H-FY19 to only $ 2.2 bln this year), we question why the IMF has not changed its BoP projection for the full fiscal year. From the IMF report, SBP’s FX reserves are projected at $ 11.2 bln by end-June 2020, which has already been exceeded by end-December 2019. This means the external sector targets for FY20 are not binding;
We observe that carry trades have exceeded $ 2.4 bln so far in FY20, which explains why the rupee has been appreciating in FY20. Having said this, the Staff Report claims the rupee has “stabilized” at 155/$, which means further appreciation is not likely. The report warns that if program objectives are not met, this could threaten this quantum of external financing;
We are disappointed that documentation is not given much importance in the report, and the likely imposition of a fixed-tax regime on traders, is a climb down. We argue that the authorities have shied away from taking difficult decisions, which means the underlying dysfunctions will remain;
We also flag that growing unemployment and job insecurity is beginning to hurt the PTI government, and if economic growth is not prioritized, pressure on the government will continue to increase;
Finally, we question why CPEC is not center-stage. We suggest that from a geopolitical perspective, the on-going EFF will not allow CPEC to anchor Pakistan’s economy.
Appreciating Rupee and growing FX reserves, support the claim that Pakistan’s economy has stabilized;
The sharp contraction of the current account coupled with rising carry trades, has pushed SBP’s reserves past $ 10 bln. SBP is now buying dollars from the interbank market to manage the Rupee parity;
The stock market rally in the past month, shows a significant improvement in market sentiments;
Fiscal revenues collected in 1Q is impressive despite the recessionary conditions. Driven primarily by GST, direct taxes still lag behind as traders refuse to document their operations – February deadline still looms;
Carry trades continue to grow but the pace has eased in recent weeks. Currency comfort will ensure that 3-month T-bills (held by foreign fund managers) are rolled-over. However, we are concerned the IMF may not approve of the appreciating Rupee;
Interest rate cuts also being delayed for fund managers to roll-over dollar placements;
M2 growth is subdued because of slow private sector credit off-take. Currency in circulation hits 42.9% of total bank deposits, a clear reflection of the resistance to documentation and using banks;
Sharp fall in current account deficit in first five months of FY20, is driven by imports (more specifically because of the economic slowdown and soft oil prices). Exports post a modest increase;
Foreign portfolio inflows in November help SBP build its FX reserves, and will make NIR targets easier to meet;
YoY inflation is likely to fall in the remaining part of FY20. Gas price increase and high food inflation are one-offs;
With the sharp containment of the external deficit, our Rupee-Dollar projections have changed significantly for FY20 – we see the parity at 160/$ by June 2020;
As GoP gears up for post-stabilization growth, it should adopt pro-market policies instead of the easier pro-business policies that suit the status quo;
CJP’s decision to invalidate the extension of COAS term, and the incendiary language used in General Musharraf’s death sentence, reveals an unprecedented showdown between two key institutions in the country. Executive appears aligned with the Pakistan Army;
Prime Minister’s last-minute withdrawal from Malaysian summit of Islamic leaders, allegedly because of Saudi pressure, shows how Pakistan’s economic weakness is compromising the country’s policy independence. This may incentivize the executive to take hard steps to address Pakistan’s economic vulnerability.
IMF review mission is pleased with progress on the EFF, and Pakistan posts a CA surplus in October after many years of deficits;
Market sentiments have improved, not just in the PSX but also amongst businessmen & corporates;
There has been an exponential increase in foreign investment in T-bills (hot money). Of the $ 1.08 bln realized in T-bills so far in FY20, $ 630.8 mln has come during the period November 1-19. With no change in domestic interest rates, we expect this momentum to continue;
This is a source of much comfort for SBP: (1) it keeps the PKR stable and builds SBP’s NIR; (2) it provides deficit financing, which means less crowding out; (3) it generates Rupee liquidity, which could allow SBP to ease its OMOs; and (4) it does not increase Pakistan’s external debt;
But hot money is a double-edged sword: this money can leave Pakistan as quickly as it is coming in. This adds a new player in the FX market, and questions are being asked whether SBP is prioritizing this player over domestic constituents;
Could this keep the PKR stable till end-December? And if so, could this trigger an import-led growth phase? Issue is: can Pakistan afford a growth phase so early in the EFF?
So far, the improvement in the external sector is driven entirely by a fall in imports (soft oil prices have clearly helped). Export growth has been anemic, while textiles are stagnant. Non-oil imports have increase in October, after trending down for most of 2019. If this continues, then we know that the import recovery is real (and could become problematic);
With the stable Rupee and stagnant retail fuel prices, inflation has peaked. We revise down our average inflation projection to 10½ – 11½% for the year. We also reduce our PKR projection to end the year at 162-163/$
Asad Umar is brought back into the cabinet as Development Minister, and strongly defends CPEC against US criticism that OBOR is part of China’s debt diplomacy;
Could this be a signal that Pakistan will prioritize real reforms and ramp up CPEC 2.0?
