The short, medium and long-term outlook with Covid-19

(June 26, 2020)

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.  Containing the pandemic should have greater priority over restarting the economy.  The logic is simple: 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, which all focus on refinancing or liquidity support.  While this may allow firms to better manage their cashflows, if the underlying demand does not pick up, refinancing will not help businesses survive. 

The federal budget for FY21 was not credible, but it does signal that the IMF’s stabilization program should restart in July.  Pakistan’s macro economy has held out quite well against the pandemic and is now better placed to handle external shocks.  In our view, 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.  While the sharp narrowing reflects the acute slowdown in the economy, as a time of global uncertainty, this is a good thing.  Inflation also 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.  

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 government policy.  Hence, Pakistan will struggle to recover compared to other countries with more documented economies. 

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Covid-19 overshadows the FY21 budget

(June 11, 2020)

This paper was published before the federal budget was announced. 

Media reports suggest that the Government of Pakistan (GoP) will announce a belt-tightening budget for FY21.  This is likely to be criticized by many since most countries are desperately trying to boost their economies.  However, we take comfort from the government’s stance as it indicates that GoP is keen to restart the IMF’s Extended Fund Facility in FY21.  While analysts may be skeptical of the 2.1% growth projection or the Rs 4.95 trn FBR revenue target for next year, we think the value of the budget is not the specific targets but the government’s intent. 

As a time of acute uncertainty because of the global pandemic, Pakistan’s vulnerable FX position requires policy caution and back-up assistance.  We argue that being actively engaged with the IMF is an insurance policy for the country. 

However, the federal budget will not be a useful guide of what to expect next year.  Without credible balance of payment projections for the year ahead, commercial entities will not be able to gauge the business environment in FY21.  We argue that the IMF’s next Staff Paper will better anchor market expectations, which in turn will determine how Pakistan’s economy will fare next year. 

Of greater relevance is the rapid spread of Covid-19 in the country.  If the spread of the pandemic is not brought under control in the immediate future, the looming healthcare crisis could easily undermine the government’s economic goals for next year.  The data on infections and deaths show that the post-Eid easing of the lockdown was premature.  While we acknowledge the government’s view that the lockdown was killing jobs – and could begin to have the same impact on the working poor – the lives-vs-livelihood trade-off is misleading.  If the pandemic continues to spread at an alarming rate, businesses will eventually stop operating, which means the economy’s ability to sustain livelihoods would be jeopardized. 

The policy priority should be to contain the pandemic, and then revive the economy. 

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Update on Covid-19 and some crystal-balling

(May 31, 2020)

This paper is split into two parts.  The first is about the incidence of Covid-19 in Pakistan, and the other is an effort to understand how the world economy is likely to be shaped by the pandemic. 

Official data reveals that infections and deaths are accelerating, while testing has started tapering since mid-March.  European countries and many states in the US have seen a fall in daily infections, which means these countries have experienced a peak.  G-7 governments have started opening up their economies after proof that they are past the peak.  In Pakistan, markets have been opened after Eid, but daily infections and deaths are still trending up.  We argue that unless the people are confident that the pandemic is under control (i.e. after we have passed the peak), the domestic economy will not recover.  With the virus spreading across the country, a much stricter lockdown is now more likely.  We also warn readers to be more cautious now than they were two months ago.  Lockdown-fatigue is understandable, but must be resisted. 

On a global level, we start by arguing that a V-shaped recovery is not likely as conventional policy tools may not change investor behavior.  Political leaders and the market hope for a quick recovery, but if the pandemic is viewed within context of current geopolitical developments, the economic recovery may be a more prolonged U-shaped.  We list six issues that may change the face of the post-pandemic recovery: (1) the growing tension between China and the US; (2) how President Trump may behave in the lead-up to elections; (3) the growing north-south divide in the EU; (4) the new normal for oil and global tourism; (5) possible complications in the development of a vaccine and the immunization phase; and (6) whether the pandemic could mark the end of the globalization era. 

In our view, the Covid-19 pandemic will exacerbate the discontent with globalization.  With leaders like Trump and Bolsonaro disgraced by their mismanagement of the virus, we hope populist politicians will lose traction.  Also, we think the pandemic has strengthened the need to tackle climate change, which bodes well for Green political parties.  However, with dystopian US leadership and a divided Europe, there is no steady hand to shape the post-globalization period. 

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Update on Covid-19

(April 13, 2020)

As the pandemic spreads globally, the impact on Pakistan is clearly being felt on the external sector.  SBP’s reserves are falling sharply as portfolio investment continues to flow out.  Since 25th March, SBP has managed to keep the currency rangebound, but this is contingent on the level of disruption to export receipts and worker remittances.  We argue that remittances could experience a step-down, as the pandemic has suddenly unhinged the GCC’s non-oil economic model.  With travel, tourism and hospitality almost falling off a cliff, and oil prices still soft despite a 10% cut in global supply, the GCC economies will experience a deep recession.  We argue that even if monthly remittances fall by $ 250-300 mln, this will hit Pakistan’s BoP and the rupee parity. 

The government has stated that it must reopen the economy, as the economic costs could be just as fatal as the pandemic.  Till now, the decision to relax the lockdown has not been announced, but we expect a construction-driven push before the month ends.  While this is the best option available, the economic revival will be partial as demand for non-essential goods and services are likely to be a fraction of the pre-pandemic level.  This means job insecurity, job losses and partial pay – the true cost of the pandemic will only be known when people get back to work. 

While the government has announced special loans to SMEs and retail businesses to ensure that employees are paid during this collapse in confidence, we are not convinced this will stop commercial entities from laying off employees.  We argue that the pandemic will hit demand hard, and the government’s efforts to revive supply will do little to increase demand.  The pandemic has created a great deal of uncertainty that impacts people’s sending behavior; this in turn determines consumer demand.  As long as people remain uncertain about the future, demand will remain subdued. 

We therefore argue that the government should focus all its attention on testing people and making this information available to the public.  In our view, more comprehensive information about the pandemic’s spread and those people who have developed an immunity to the virus, will allow private businesses to better plan for the future.  Compared to subsidized or interest-free loans, greater certainty will be more effective in limiting the economic downside. 

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SBP versus MoF (and more)

(April 09, 2020)

A media report about growing tensions between the central bank and the government, is a disturbing development.  This comes from the amended SBP Act, which was sent to the Law Ministry to be tabled for parliamentary discussion.  The latter was an IMF target for end-March. 

The report claims that SBP’s amendments were: to disband the Monetary & Fiscal Policies Coordination Board; eliminate government guaranteed lending by commercial banks; remove the Secretary Finance from SBP’s Board; increase the term of the SBP governor to 5 years, with the possibility of one extension; and effectively curtail the government’s ability to remove the SBP governor before his/her term is done.  While enhancing SBP’s autonomy has been a persistent part of past IMF programs, this is far more ambitious.  As expected, it triggered a strong – but anonymous – pushback from the Ministry of Finance (MoF). 

We argue that increasing SBP’s autonomy is a good thing, but if this is used to narrow the focus of the central bank, it would be unwise.  More specifically, if SBP adopts a single-minded focus on inflation control using inflation targeting, this may create an environment whereby SBP would be operating at cross purposes with the government. 

We are concerned that this standoff could complicate the EFF, and do not expect MoF to be too heavy handed.  In our view, this entire issue is the result of very poor timing.  In the midst of the global pandemic where the government has been scrambling to stay ahead, this demand for greater independence should have been delayed.  As the economic cost of the pandemic becomes clearer in Pakistan, both institutions need to be working together instead of carving out spheres of influence and staying aloof. 

We end with a few takeaways about the pandemic: (1) the longer the lockdown, the more dysfunctional the economy becomes; (2) financially desperate people are more likely to defy the lockdown; and (3) the growing uncertainty will sharply reduce demand for non-essential goods and services.  In effect, the pandemic has posed a very uncomfortable policy tradeoff: the health of the people against the health of the economy.  The only consolation Pakistan has is that this impossible choice is being faced by every country in the world. 

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Rupee comes under pressure and may remain stressed

(April 03, 2020)

Two pieces of economic data captured media headlines: the 220 bps fall in YoY inflation in March, and the unexpected weakness of the rupee on the 25th of March.  The cause for the sudden weakness of the rupee can be traced to the retiring of dollar loans by importers, when the latter realized that the pandemic could add further pressure on the rupee. 

While the economic impact of the pandemic is yet to be quantified, it is clear that the GCC will be severely impacted.  Oil prices have collapsed and so has travel/tourism, which means the abrupt slowdown in economic activity in the GCC, could reduce remittances into Pakistan and keep the rupee under pressure.  With a bleak global outlook for the next several months, we see the currency weakening to 173-174/$ by June 2020. 

SBP’s FX reserves will fall and the outflow of portfolio investment will continue, but social concerns now dominate policymaking.  Since the bulk of non-farm labor works in the undocumented sector, the lockdown is taking a serious toll on daily wagers.  The Prime Minister has stated that Pakistan cannot extend the lockdown indefinitely, and there is no choice but to move towards reopening the economy.  The government has announced special incentives for the construction sector, which specifically targets daily wagers and creates demand for a host of ancillary industries.  In the paper, we suggest a number of steps to ensure that the end of the lockdown is not chaotic nor does it unleash a larger health crisis. 

This pandemic is only about hard choices: more people will be infected and die; businesses will suffer; people will lose jobs/livelihoods; markets will remain volatile; investment will stop; savings will be depleted and wealth will be eroded.  This may remain in play till a vaccine is created, tested, mass produced and administered, which could take up to a year.  Nevertheless, this crisis gives the government an opportunity to prove its worth.  In this period of uncertainty and fear, the government should do things it would otherwise shy away from.  In this period of Covid-19, it should consider implementing disruptive economic reforms. 

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Grouping to contain the coronavirus pandemic

(March 26, 2020)

This paper tries to do two things: one, discuss how the pandemic will impact Pakistan’s marco economy; and two, how G-7 governments are scrambling to understand the impact of this pandemic, and the difficult choices they face. 

As of now, the spread of the virus in Pakistan has been contained.  We agree that this is because of the lack of testing and/or that a large number of people have been infected but not diagnosed as such.  It is safe to say that infections and deaths will increase, and the country’s health infrastructure will be tested to the breaking point.  In terms of the economy, the out-of-schedule 150 bps cut in rates on March 24th, reflects two things: the need to be ahead of the curve (after the disappointing 75 bps cut on March 17th); and the likelihood that YoY inflation will fall sharply in the next two months.  The Rs 1.1 trn relief package announced by the PM on March 24th, will include a Rs 15/liter cut in retail fuel prices.  This will reduce our annual inflation projection to 10.8% in FY20, with YoY inflation in June at only 8%.  Growth will also take a hit, but since Pakistan was already in a recession before the pandemic, the most obvious impact of the virus is to delay the economic recovery.  This will also shift the focus away from austerity, which is one positive for Pakistan; another is the collapse in oil prices. 

The global challenge is unprecedented.  24-hour media outlets are reporting with a sense of urgency, which has caught many G-7 governments off-guard and on the defensive.  While most OECD countries have locked down their cities to stop the spread, the economic cost of this lockdown is increasingly obvious, specially since there is no end in sight.  We argue that lockdown is only a holding pattern, which gives the country some time to gear up its medical response (i.e. to flatten the curve).  If a vaccination is 12-18 months away, some people have argued that the cure may be worse than the disease.  This means the cost to the economy (unemployment, recession) cannot be ignored, even though the priority is to sharply reduce the infection rate.  In our view, a lockdown is necessary to build medical capacity, but eventually less vulnerable people should be allowed to return to work.  In effect, till a global vaccination has been administered, herd immunity may be the only viable option.  This is not easy to advocate (i.e. people take their chances and develop immunity after a mild infection), but this pandemic cannot be ignored and there are no good options. 

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Rising inflation amidst subdued demand

(February 06, 2020)

This paper seeks to explain how inflation exceeded 14% in January 2020, despite subdued demand in the economy.  The explanation is simple: YoY food inflation almost touched 24% last month, and this category is the heaviest in Pakistan’s consumer price index (CPI).  With the government scrambling to control food inflation, we expect inflation to begin falling in the months ahead, and just as the January number surprised the market, the fall in inflation could be just as sudden. 

While this development contradicts the neoclassical view that inflation is driven by demand pressures, it again questions the need for SBP’s stated objective to target 200-300 bps real interest rates.  In our view, it will be hard for SBP to resist pressure to cut rates in March, and a token cut will not suffice – we suggest that SBP could cut rates by 75-100 bps.  As we have hinted at before, if the FBR revenue target become challenging in FY20 (as is likely), GoP may encourage imports as the bulk of FBR’s revenue collection is done at Karachi ports.  We summarize by noting that GoP may use the external sector gains to increase revenue collection, but the price it will pay is the growing burden of carry trades.  Word count: 1,184. 

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Assessing the IMF's assessment

(January 14, 2020)

The IMF’s Staff Report published on December 19, provides a good handle to gauge how Pakistan is doing in the EFF.  The report reveals that the IMF was just as surprised as the GoP about how sharply the current account deficit has narrowed in FY20 (the CA deficit has shrunk from $ 6.7 bln to only $ 1.8 bln in the first five months).  This comfort means the hard targets for the external sector were achieved by significant margins.  Since subsequent targets have not been adjusted accordingly, meeting them should be easy enough.  The fact that the Staff Report endorsed Rs 155/$ as a stable equilibrium, suggests that SBP will not allow the rupee to appreciate beyond this level. 

The fiscal side is less heartening.  Unlike government sources, the IMF report explains the cause of the fiscal fiasco last year, when the authorities admitted that the fiscal deficit in FY19 was 8.9% of GDP against a target of 7%.  It also reveals that against a primary deficit target (ceiling) of Rs 102 bln in Q1, Pakistan over-performed by posting a primary surplus of Rs 305 bln.  The report explains that this was because of one-off non-tax revenues, which means subsequent revenue targets will be challenging.  The full year FBR revenue target has only been reduced by Rs 265 bln, to a still ambitious Rs 5.24 trn, with Rs 3 trn to be collected in 2H-FY20. 

In terms of tone, the Staff Report was surprisingly somber.  Against the stock market optimism that the country would soon enter a growth phase, the IMF report talks about elevated risks and the need to stay firm with program objectives.  The report reveals that 15% of direct taxes and 58% of sales tax are collected at the customs stage, which shows that tax assessment and collection is concentrated at the import stage because it is easier to collect.  We take this as proof that Pakistan’s economy is largely undocumented, but were disappointed that the IMF had little to say about concrete steps to enhance documentation.  The report also reveals the lack of an action plan to meet the ambitious revenue targets. 

Our paper also touches on the concern that the likely amendment in the SBP Act to make price stability SBP’s primary objective, is not in the country’s interests.  We also highlight how the sharp increase in GoP’s cash buffers have spiked Pakistan’s domestic debt.  We conclude by saying that revenue challenges are likely to dominate policy thinking, while more fundamental structural reforms could be delayed.  We think this EFF is being managed as previous programs were (in a business as usual approach), which is not a good omen.  However, with $ 1.6 bln worth of carry trades in the country, this exposure does weaken the country’s ability to negotiate with the IMF. 

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