Pakistan has finally clinched a staff-level agreement with the IMF, with the successful conclusion of the combined 7th and 8th reviews. The EFF loan has been extended until June 2023 and its size has been enhanced by US$1bn to US$7bn. Pakistan will be able to obtain US$1.18bn upon the IMF Executive Board’s approval, which will help unlock additional funding and enable Pakistan in overcoming the estimated external funding requirement of US$45bn until June 2023. We expect a more timely Board approval, unlike the last time when it took nearly three months to release the tranche, as most prior actions appear to have been taken already.
Budget implementation is key
The IMF requires a primary surplus of 0.4% of GDP. Despite revised tax measures targeting 29% higher collection in FY23, the revised budget document only targets a primary surplus of 0.2% of GDP (see annexure). We believe this will largely require restraining current expenditure (only up 5% in the budget) and perhaps further revenue generating measures, as also highlighted in the IMF communique. Pakistan has historically seen heavy slippages on the primary surplus target, and it will have to demonstrate strong fiscal discipline (at both the federal and provincial levels) if it is to remain compliant with the IMFs requirements, while duly focusing on social safety and development projects.
Interest & exchange rates
The IMF has expressed satisfaction at the SBP’s recent 125bps increase in the Policy Rate to 15.0%, and continues to advocate a proactive and prudent monetary policy. As a result, while domestic interest rates may arguably have peaked, the monetary easing cycle may not commence until mid-2023, in our view. At the same time, the IMF has stressed upon the continued need to adhere to a market-determined exchange rate. The current REER level of 93.6 suggests room for the PKR to strengthen to less than 200 vs. the USD, but the gradual buildup of FX reserves may keep the exchange rate on the stickier side.
Power sector reforms
Pakistan witnessed a rise of PKR 850bn in circular debt in FY22. However, the subsidy allocated to the power sector has now been reduced to a large extent. The ongoing gas price rationalization, along with expectations of a c.50% hike in the base electricity tariff will enable Pakistan to slow down the accumulation of circular debt. As per the IMF, a quicker mechanism needs to be deployed to overcome the administrative roadblocks that tariff revisions face.
Re-rating is overdue
The KSE100 has gained 2.4% (PKR terms) in the previous two trading sessions. Valuations continue to remain attractive where forward P/E is 4.3x vs. the last 10yr average of 8.1x, and market capitalization-to-GDP is 13% vs. the last 10yr average of 19.4%. Risks emanate from politics and an economy that has little shock absorption capacity. In this regard, the upcoming by-elections on 20 seats vacated by the PTI in Punjab will give a sense of the popularity of incumbent government, although, a further test will come from the IMF’s fresh requirement of enhancing governance and anticorruption measures. In the near-term, the resumption of the IMF programme will help rescue Pakistan from the brink of default and continue the bounce in equities.