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The global turmoil is not just about the tariff rates the US had imposed, or their global reach, but the last-minute reprieves and contradictory statements made by Trump. Unless you are an importer in the US, it is hard to know what the current tariff incidence is. Mainstream media has nothing positive to say about this Trump-driven turmoil, but it also doesn’t have the depth to understand how the US, as the issuer of the global reserve currency, suffers from persistent overvaluation of the dollar, and how this has de-industrialized the US economy.
There are competing models of how currencies reach their equilibrium level. The trade model says that countries that run persistent external deficits should witness currency weakness. The financing model focuses on global investments in financial instruments, and claims that currency equilibrium is achieved when global investors are indifferent between dollar and non-dollar investments. The Triffin Dilemma focuses on the reserve currency (the US$), and shows that the trade and financing models don’t work because there is always strong demand for dollars as global trade grows.
Since global trade volumes have increased sharply in the past several decades, the dollar is persistently overvalued, which makes the US manufacturing sector less competitive. The Triffin Dilemma basically says that for the country issuing the global reserve currency, there is a conflict between domestic economic goals and its global obligations.
An overvalued dollar allows the US to keep interest rates low and gorge on cheap imports, but it also makes US manufacturing less competitive. The era of globalization has seen parts of the US reduced to ghost towns with impoverished residents, which explains Trump’s popularity with diehard MAGA supporters.
Stephen Miran, the head of the Council of Economic Advisers, had released a paper in November 2024 where he spelled out Trump’s tariff plan that is currently playing out. His assessment that US manufacturing needs to be rebuilt, and blue-collar jobs need to return, has strong political overtones but also has common sense logic. Using the Triffin Dilemma and simple language, Miran argues that Trump is trying to address the structural bias against US manufacturing by forcing trading partners to share the economic burden of issuing the global reserves and the defense shield the US provides to Europe and Southeast Asia.
However, Miran’s arguments are not water-tight, while Trump’s rambling narrative on tariffs has created utter confusion about what the US is trying to achieve. In simple terms, if Trump wants to create blue-collar jobs and reduce the US trade deficit, he must sharply increase the price of imported goods even if it spikes US inflation and hurts US tech firms. If he wants to impose tariffs and keep domestic prices down, he needs to depreciate the dollar and move away from being the global currency. He cannot do both.
We argue that Trump’s political instinct is to prioritize domestic goals over global obligations. However, his insistence that the dollar remains the global currency and US prices remain low, will not bring back blue-collar jobs to the US. Trump desperately needs a consistent economic roadmap, as his desire to achieve contradictory goals will only serve to isolate the US. With time, the rest of the world will find alternative trade and security arrangements where the US has no role. This means Trump is accelerating the demise of US power.
Trump’s tariff announcement was worse than anticipated. Across the board and not sparing allies, even close ones like Israel and Taiwan. Analysts were quick to point out that the tariffs computed by the White House were flawed, but we think that point is irrelevant. Trump will never acknowledge his mistake and will only double down.
What’s more important is how this tariff war is being perceived by the Trump administration. On paper, it is moderate (only half the alleged tariffs imposed by countries on US exports) and unbiased (friend and foe are seen as one). The world is scrambling to respond, with indications that China will impose counter-measures against the US, while the UK may let this one slide. The EU is talking big, but is unlikely to deliver.
The pain is already being felt. Not the rise in US retail prices, but the job losses in Canada, which are likely to happen in Mexico. For export-led countries, the challenge is existential. Pakistan has been aspiring to be an export-led country for decades, but has never managed to achieve it. Perhaps that is a blessing now. In our view, Trump’s tariffs will not be as disruptive to Pakistan as they will to most other countries. Some local analysts are already looking at the opportunities it could create for our exports of textiles and garments against countries like China and Bangladesh.
While the US will be willing to consider side deals on a bilateral level, US tariffs are here to stay. This means most OECD countries will slip into recession, and global trade flows and investment could become more regional. Trump’s tariff war is really about how developed nations are able to manage the resulting economic pain. The US is better placed than the EU and export-led countries in Southeast Asia. We also predict a shift in power within the Trump administration, as globalists like Elon Musk are eclipsed by nationalists like Steve Bannon.
The pace at which President Trump is challenging the global order,… is dizzying. Over the weekend, his administration has said that returning to Ukraine’s pre-2022 borders is unrealistic, that Europe’s security threats are from within (not from Russia and China), and that Palestinians should be relocated from the Gaza Strip so that the US could take charge of the area. And it’s been less than a month since Trump took charge.
This paper seeks to understand why the US view has changed so radically. We argue that the Trump administration sees the challenges facing Western Europe as similar to the US, and suggests that Europeans should focus on immigration and stop discriminating against right-wing political parties. We also think this transition of Pax Americana, requires changes in how Western European countries view NATO and the threat from Russia.
With the rise of right-wing parties in Europe, Trump thinks there is popular support to dismantle the old system, which could be an existential threat to the European Union. As someone who prefers bilateral deals to collective actions, we argue that Trump would be happy to see the end of the EU and NATO. Shifting away from a rules-based system could result in significant changes in the United Nations – its Charter and perhaps the composition of the permanent members of the Security Council, with India replacing the UK and France.
The world, according to Trump, should focus on how the real powers set their own agenda, which is unhindered by global institutions and international law. As he has already done, the use of tariffs to secure revenues, bring back jobs, and secure concessions from US trade partners, has already made some global institutions irrelevant. In our view, the big boys are the US, China, Russia, and India, who will deal with each other and carve out their spheres of influence.
Pakistan is not well placed to adapt to the new world order. Its democratic foundations have been systematically weakened, and its economy needs the IMF. The composition of the Trump administration and Modi’s state visit to the US, suggests the US may not have a favorable view of Pakistan. While most countries will struggle to position themselves in the new world order, Pakistan is particularly vulnerable. If Pakistan’s power brokers do not accept the need to challenge the entrenched status quo, it could become globally isolated. With weak global institutions, being left behind could be an existential threat.
The conviction of PTI supporters in military courts and the almost immediate mercy granted to some, has raised eyebrows. Against the backdrop of Grenell’s repeated tweets to release IK, people sense that something is happening behind closed doors.
Pakistan may not be high on Trump’s agenda, but the similarities between IK and Trump cannot be denied. For someone who has always complained about being targeted by the deep state – which he has vowed to dismantle, Trump will see IK’s incarceration as a misuse of power by our deep state. The timeline for a deal between the incoming Trump administration and the Establishment is short, as Trump’s inauguration speech is only weeks away.
IK’s possible release and early elections will go together. We argue that the evolution of hybrid arrangements in Pakistan has weakened public support for the Establishment as it gains more executive power. Print media has become vocal about rising authoritarianism in the country and how Pakistan’s Western provinces are being mismanaged. The need for political solutions to Pakistan’s myriad problems is glaringly obvious.
With the backdrop of potentially monumental changes in the world order after Trump takes charge, a reconciliation between the Establishment and IK may not attract much global attention. With EFF reforms on the back burner – lots of talk but no action, Pakistan needs a strong government to implement structural reforms. A political transition in 2025, with the Boys stepping back, may be the right solution for the country.
Trump is moving fast to create his team. The nominations show that Trump intends to deliver on his campaign promises to deport undocumented migrants, downsize the federal government, clean up what he calls the deep state, facilitate the fossil fuel industry, and impose tariffs on China, which now includes Mexico and Canada as well.
This paper seeks to analyze the impact of US tariffs. While the conventional wisdom is that tariffs reduce global welfare via the gains from free trade, one must realize that the Neoliberal order is the exception in US history, not the norm. Tariffs protect domestic industry and blue-collar workers with the larger goal of prioritizing its own citizens. Trump will surely deliver on his promise.
Unilateral tariffs reward the imposing country at the expense of its trade partners. This is well documented as beggar-thy-neighbor policies were often used before WW2. We argue that Trump’s tariff policy is primarily aimed at achieving domestic political goals, and while he will be able to bully Mexico and Canada – which are acutely dependent on the US market for their exports – this will not work with China. Such a move will trigger counter-tariffs against the US, which could unleash trade wars where powerful economies use the threat of tariffs to gain an advantage over trade partners.
Pakistan is not as vulnerable to trade wars as countries like Hong Kong, Singapore, Vietnam, Ireland, the UAE, and Malaysia. The real risk is the escalating nature of trade wars, as aggrieved countries will strike back. With the US taking the lead, global agencies like the IFIs will be unable to punish trade aggressors, which could result in the end of the rule-based global order.
While this may seem a regressive step in global progress, one must realize that the gains from free trade are often concentrated on a small elite. The resulting income inequality has created a growing demand for restricting trade and immigration, which has taken root in the US and Europe. We can only wait and see how this plays out when Trump takes the oath of office on 20 January 2025.
The IMF Staff Paper was released after an unusual delay. Media coverage has been extensive, with a specific focus on the dismantling of agri support prices, the expected mini-budget, winding up special economic zones, and clipping the powers of SIFC. The document supports Pakistan’s economic management and praises the macro stability that has been embedded since mid-2023.
Instead of repeating this discussion, we have focused on the IMF’s 5-year projections of key macro variables. The point is not to hold the IMF to account when the projections are not realized, but to see how the recent projections compare with the IMF’s projections from July 2023. Behind all projections are specific assumptions, and this exercise seeks to gauge how the IMF’s assumptions about Pakistan have changed in the past year. More specifically, we compare the Staff Paper from July 2023 and the one just released, and focus specifically on Pakistan’s fiscal accounts, its BoP flows, and the country’s external financing needs and sources.
The IMF’s perspective has changed with the following insights for the next five years:
From the Staff Paper, we would suggest new certainties: the tax base must be increased; development spending cannot be squeezed; the IMF will not be generous with waivers for failed targets; economic decision-making must be transparent; and Pakistan must deliver on its promises to use digital means to ensure tax compliance. This may sound familiar enough, but we sense some urgency in the IMF’s tone.
Nawaz Sharif’s relief package for small residential users, which was announced in mid-August, is a breach of the EFF’s conditions. Shahbaz Rana (Express Tribune) put out two articles on this issue early this week, which cleared up our thinking of the main impediments to securing the EFF. In Rana’s 3 September article, he reported that the IMF characterized the relief package as fiscally reckless and imposed three additional conditions in the EFF, which effectively means that provincial governments cannot make economic policy decisions without consulting the federal government. It also said the IMF expects the subsidy provided to Punjab to be reversed by the end of September.
Rana also broke the news (2 September) that the federal government was in discussions with the IMF about extending the relief package to the entire country for the entire year (FY25). This means a standoff with the IMF, which should play out this month. NS is an astute politician who realizes the performance of the PML-N government has been poor, and people are angry with their elevated electricity bills. To be forced to back down and accept the IMF’s demands could end Nawaz Sharif’s 40-year political career. Hence, Nawaz Sharif may not comply with the Fund and opt for Plan B, which means managing the economy without the EFF. This is inherently problematic, but it does provide space to score political points with his supporters.
In our view, Plan B entails extending the power relief package to the entire country in FY25. It could also mean that FBR backs away from its confrontation with the trader community, since Tajirs are an important constituency for PML-N in Punjab. However, without an EFF that will unlock fresh $s, managing SBP’s limited FX reserves will become challenging. We argue that with hands-on management of $ flows (which Dar is capable of), Plan B could be sustained for 3-4 months (with some growth) or 6-7 months with lower growth. The goal of Plan B is purely political: to provide relief to the people and generate political support for PML-N – especially in Punjab.
Plan B’s end game is vague, but we argue that when SBP’s FX reserves reach dangerously low levels, the government will call for early elections knowing that PTI’s support base would return IK to power. IK would then have to implement the IMF’s harsh measures, which could dissipate public support for PTI and IK.
PML-N is part a coalition government, but by managing the Center and Punjab, it decides where Pakistan goes – the others have little choice but to accept it as fait accompli. This includes the Establishment, which will not be happy going off the IMF track but really has no say in the matter. Having a common enemy in IK, it may concede to NS’s bold mid-August gamble.
This paper is a departure from the past. We have been arguing that from an economic perspective, there is much confusion about the forthcoming budget, which should be the roadmap that has been vetted by the IMF. The issue becomes what will parliament accept, what will it reject, and how will the IMF respond. However, if one looks at the budget from a political perspective, the outlook is less confusing.
Building on events from early 2022 (when Russia invaded Ukraine) we focus on the political maneuvering that resulted in the vote of no confidence against the PTI government. Just months after IK’s February relief package, the PDM government took responsibility for a hemorrhaging economy while trying to revive the IMF program. The sharp increase in fuel prices in May-June 2022 ignited inflation which would eventually average 30% by mid-2023. This hurt PML-N politically, which was unable to recover even by the 8 February 2024 elections.
NS initially withdrew from active politics, lamenting his past treatment and Pakistan’s lost economic potential. However, in recent months he has become politically assertive, by elevating Ishaq Dar as Deputy Prime Minister and retaking the presidency of PML-N. As the FY25 budget looms, we suggest a possible political scenario that could play out on 12th June.
In this scenario, PML-N could reject the IMF-vetted budget and opt for a populist relief package that entails slashing interest rates, cutting fuel prices, capping power tariffs, overtaxing captive payers, and strict controls on the FX markets (aka the Dar exchange rate regime). This would be a short-term strategy to shore up NS’s fading political fortunes by wading into an economic abyss. As the economy slowly gets paralyzed, the government could call for early elections, which most people predict will be swept by PTI. In effect, this would be a replay of what happened in February-April 2022, when IK announced an unsustainable relief package, handed over the reins to the next government, and then blamed the government for his policy mistakes. This time around, PML-N will announce an unsustainable relief package (by rejecting the IMF) and just before the economy seizes up, call for early elections, and hand over the economy to the next PTI government. To facilitate this, the judiciary will be nudged to release IK from jail and allow him to participate in the next elections.
This is one possible scenario, but looking at it from a political lens, it is compelling. If there is a U-turn on 12th June, this should not be viewed as a cataclysmic event but just another political play with the Pakistan economy held hostage.
This short paper is based on an article written by Shahbaz Rana in the Express Tribune on 2 June. Because of the stability of the rupee since November 2023, and in the run-up to the FY25 budget, the market and public pressure is mounting for a people and market-friendly budget. Extrapolating on the content of this article, we project what the IMF and MoF think the rupee-dollar parity will look like in FY25.
The MoF is working on the assumption that the rupee will average 295/$ in FY25, while the IMF thinks the rupee could hit 328.4/$ in June 2025. Doing the numbers, there is a significant divergence between the two viewpoints, which will have a direct impact on inflation next fiscal year. MoF is of the view that average inflation will fall to 12% in FY25, but incorporating MoF’s projections into our supply-driven model predicts average inflation at 17.5%. If we use the IMF’s projections, inflation could exceed 22%.
Since both institutions see a weaker rupee in FY25, the anchor for economic stability will end soon. If this drives inflation beyond GoP’s projection, and SBP tries to keep the rupee on track, the resulting overvaluation of the rupee could increase the trade deficit. Exporters, who are already angry at the sharp increase in energy costs, may respond by reducing exports.
In terms of interest rates, the 11.8% YoY inflation in May will put tremendous pressure on SBP to cut rates next week. We think a 200-bps cut is likely, but future cuts will depend on the IMF’s prior actions and their impact on inflation. In our view, interest rate cuts in FY25 are unlikely.
The economic pain the IMF program has in store will be incredibly challenging for a weak coalition government. The PM is already showing signs of dithering, which means parliament may reject fundamental pre-conditions for the IMF program. In our view, Pakistan has never before faced such a stark choice between the political demand for relief, and the economic compulsion to bite the bullet.
The latest IMF Staff Paper was released on 10 May. As expected, the focus was on expanding the tax base, timely tariff increases to freeze the circular debts, a flexible rupee, and restructuring all SOEs without exception. Compared to past Staff Papers, the latest one is uncharacteristically blunt about the exceptionally high downside risks that Pakistan faces.
While we are also apprehensive about the 7 June budget session – this will be an austere budget within the backdrop of two years of 20%+ inflation – the IMF’s 5-year macro projections reveal the IMF’s roadmap to recovery. Projecting so far into the future is a tricky exercise, but it suggests how the external and fiscal sectors should be managed.
We focus on six sets of projections to better understand Pakistan’s road to recovery:
The IMF will insist on positive real interest rates, not to reduce inflation but to keep import demand down. Hence, Pakistan will have to live with elevated interest rates and inflation. Furthermore, there is no room for import-driven growth in the next five years. Finally, if the authorities fail to document and tax non-filers, the IMF will insist the burden be placed on the average citizen via fuel prices and utility rates.
The government realizes the budget session will be exceedingly difficult, but it doesn’t have a choice but to announce the IMF-vetted plan. The choice is stark: push through the difficult legislation and deal with the political and public pushback, or Pakistan could be staring at sovereign default in 2024.
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