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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.
With YoY inflation falling in March, expectations are growing that interest rates will soon be cut. Building on expected IMF requirements and the recent hike in energy prices (utilities and fuel), we have projected inflation for FY25. The outlook is not as heartening as the government would have us believe; we predict average inflation in FY24 at 25.6%, and only a slight improvement next year as our model projects average inflation at 23.0% in FY25. In effect, the inflationary pressure that Pakistan has experienced in the past two years, will persist in FY25.
Driving this persistent cost of living increase is the price of energy (electricity and gas tariffs, and the retail price of fuel) and a more flexible rupee as the government seeks a longer-term IMF program. Fuel prices are expected to increase in Q4-FY24 as GST could be imposed to shore up revenues this year, while there are strong expectations the PDL ceiling (currently at Rs 60/liter) could be increased in the Finance Bill for FY25. The point is that taxes on fuel are easy to collect, and if the government is concerned about its primary surplus target for FY24 (which will be an indicative target for the next IMF program), a tax on fuel is an easy and predictable source of revenues.
Food prices will be difficult to manage as transportation costs will increase with diesel prices. Our model shows that while average food inflation has been falling since September 2023, it could start increasing from January 2025. Similarly transportation costs could start rising from January 2025. The cost of household utility bills has been increasing since September 2023 and is projected to peak in October 2024 at 38.7%. Since food, utilities, and transportation, accounts for over 64% of the CPI basket (which is a proxy for the spending pattern of the average household), FY25 will be another difficult year for the average Pakistani.
With sluggish GDP growth projected till FY26, and salaries unable to match the rise in prices, most households could experience a 15-20% fall in purchasing power in the two years till June 2025. Many of these households will fall below the poverty line.
With no fiscal space to protect consumers, and an added goal to force non-filers into the tax net, the challenges ahead are significant. Many will argue that this government does not have the political will to deliver on these promises. In our view, the IMF is not in a compromising mood with Pakistan, and will insist on additional revenues, no subsidies, no increase in the circular debts, and to sharply reduce the hemorrhaging in SOEs. This is a make-or-break moment for Pakistan; if the country cannot deliver, it may still stumble into sovereign default. It’s effectively a choice between taking on the sacred cows or watching the entire economy implode.
This brief note is in response to a request from a leading brokerage house in Pakistan.
The PSX bull run has seen a correction, but this has not dampened market confidence that the newly elected government, especially one led by PML-N, will return Pakistan to a path of prosperity. We argue there are serious headwinds ahead, and Pakistan would be lucky if FY25 were a replay of the current fiscal year.
First is the IMF program. While the SBA is going well, there is a growing list of structural reforms the new government must implement. This includes cleaning up the discos, reducing the pension burden, getting retailers into the tax net, restructuring loss-making SOEs, and privatizing PIA. Initial steps have already experienced pushback from FBR and the Establishment Division, and we think the newly elected government will be hard-pressed to implement these painful reforms. If the discussions with the IMF begin to stall, Pakistan could experience a risk-driven import compression, whereby foreign suppliers may shy away from shipping goods to Pakistan if they are not sure they will be paid. This would have devastating consequences for the economy.
Similarly, bullish market players are convinced that Pakistan will see sharp interest rate cuts in the longer-term EFF. We argue that inflation is falling but will not reach levels that would justify aggressive rate cuts. Furthermore, Pakistan’s BoP cannot afford an import boost that may follow aggressive rate cuts. The IMF’s projections show a gradual increase in FX reserves till FY29, which means it will not allow for an import-driven growth phase for the next several years.
Then there is the issue of how foreigners perceive Pakistan, especially the ham-fisted preparation for the Feb 8 elections. The New York Times has said that the forthcoming elections are the least credible in Pakistan’s 76 years of existence. With foreign inflows in short supply, securing $s from private sources requires political stability. The global and domestic news stream about Pakistan’s politics is anything but supportive.
Finally, global risks are rising. The standoff between the US and Iran could escalate, and if it becomes a hot war, global commodity prices will surge. This will instantly reverse Pakistan’s economic stability, as GoP does not have the fiscal space to protect consumers from rising oil prices. The war on Gaza is cementing the East-West divide, while the Global South is likely to side with the East. A war in the Middle East could be a trigger to create a multipolar world order, and a degree of economic dislocation is likely.
We thought the IMF Staff Paper (SP) would provide details of the reform agenda for the next several years, shore up momentum for structural reforms, and build confidence in the economy. Unfortunately, the document only had targets for end-December 2023, simply to anchor the 2nd review mission. While the SP was light on the reform agenda, it has repeated warnings of the exceptionally high risks to the ongoing SBA if the authorities do not deliver on its policy commitments.
The SP focuses on specific issues, alongside the groundwork to meet structural benchmarks for the SBA. The latter includes bringing the power sector under federal government control; forcing all SOEs (even profitable ones) under the umbrella of the SOE law; and restructuring FBR. The areas of policy focus (the gas sector, need for a mini-budget, and specific risk warnings) have specific messages for the authorities: (1) the sharp increase in the gas circular debt must be arrested immediately; (2) if FBR targets are missed, the authorities must release a mini-budget; (3) the external financing gap remains problematic, and without timely disbursements, the economy could suddenly destabilize; (4) the exposure of banks to the sovereign has reached alarming levels and demands fiscal consolidation or alternative source of financing; and (5) a shot across the bow for the SIFC.
With guarded language, the IMF has warned that special treatment for GCC investors is unwise, and all foreign investment must be transparent and based on a level playing field. In our view, the IMF does not want elite capture by select foreign investors, just as it is trying to dismantle the domestic elite capture. As the SIFC was created primarily to attract investment from the GCC but has since evolved into the apex decision-making body, the IFIs are closely watching how this army-government council will be incorporated into the existing system.
In terms of the five-year projections, these were disappointing. In our view, previous projections were tweaked using recent data but do not account for the seismic changes that Pakistan experienced in FY23. The key takeaway is that a credible reform agenda and projections will only be available after the next EFF is approved. This will be a long wait, especially since the next government will likely be a weak coalition.
We conclude by saying that structural reforms require a plan and a justification. So far, the structural benchmarks are standalone tasks without a holistic picture of why they are needed. Since the next government is not likely to have the traction to push through tough reforms, perhaps defacto default (and the devastating economic consequences) is the only way to motivate people and policymakers to do the right thing.
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