Strategy Note /

Pakistan: Crackdown on protests and IMF talks futile, but value reflects crisis

  • PMLN-PPP (Sharif-Zardari) government's arrests, blocks (legal, road, internet), tear gas don't deter PTI (Khan) protests

  • IMF loan talks fail to re-track disbursements with government unwilling to cut the subsidies it inherited from PTI

  • Urgent economic decisions left hanging as PMLN-PPP fight for survival amid PTI call for election; military silent so far

Pakistan: Crackdown on protests and IMF talks futile, but value reflects crisis
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Patrick Curran
Tellimer Research
26 May 2022
Published by

A political rubicon has been crossed in Pakistan on 25 May with the PLMN-PPP (Sharif-Zardari) government's use of preemptive arrests and laws banning mass gatherings, uniformed and plainclothes police, road and internet blocks, and tear gas shells against the multi-city protests, calling for an early general election, where protestors include women and children. Protests are ongoing at the time of writing.

A macroeconomic abyss is also coming ever closer with this week's negotiations between the government and the IMF concluding on 25 May without reaching an agreement. Despite, in the IMF words, "considerable progress", the sticking point remains the fuel and energy subsidies. Those were introduced by the former PTI-led government in February 2022 but the new PMLN-PPP government has so far refused to cut them.

No party disagrees with the need for the IMF, but no one wishes to bear the political cost of cutting subsidies.

For investors, it may well be the case that the economically most damaging scenario, an extended opposition sit-in that paralyses the economic policy of an already slow-moving government, plays out. But this may already be reflected in a Eurobond valuation that is near recovery value and equities that are cheaper, relative to historic average, than almost any other in emerging and frontier.

Three scenarios from this point

Politics, and by implication, economic policy, might progress along three scenarios, with our judgement of the probability attached to each.

  1. 50% probability: A long mass sit-in by the PTI supporters – following a resumption after the six-day ultimatum for the government to announce new elections passes – with an ultimate arbitration with the PMLN-PPP conducted by the military-intelligence deep state, and an eventual election — would be the longest and economically most damaging outcome as the government will struggle to implement difficult decisions (ie subsidy removal, IMF negotiation) when its political mandate is so weak and under constant threat.

  2. 45% probability: Swift resignation by the PMLN-PPP government (perhaps after actions which enhance their chances of evading prosecution for alleged historic corruption), dismissal of parliament, call for early elections, and the installation of an interim, technocratic government willing to take unpopular economic decisions to resuscitate the IMF loan and associated bilateral assistance.

  3. 5% probability: Swift imposition of martial law under the "doctrine of necessity" in order to restore domestic security, with a commitment to an eventual restoration of the electoral cycle, technocratic economic policy stewards appointed to resuscitate the IMF loan and associated bilateral assistance.

Three actors in this drama

PTI opposition

The motivation of the PTI is to apply pressure for an election. They feel their narrative, that of a parliamentary and judicial coup engineered by a corrupt domestic political cabal and endorsed externally by the US, has been embraced by the electorate, as evidenced by rallies on a scale and geographic spread without recent precedent.

The veracity of that sensational narrative is, of course, open to debate (and, under other circumstances, their main vulnerability might have been their operational competence when in power). But what is beyond doubt is the scale of the PTI's mass support. This demonstrably cuts across a sufficient cross section of the geographically dispersed populous areas with large parliamentary seat counts, ie the provinces of Punjab and Khyber Pakhtunkhwa, and the metropolis of Karachi, as well as across social divides of urban and rural, educated and uneducated, rich and poor.

The expediency of the PTI leadership is also clear in a recent softening of their rhetoric on the military establishment compared to the thinly veiled references and criticisms during their last days in power. For all his charismatic, uncompromising, idealist, and populist rhetoric, Khan is a politician.

PMLN-PPP government

The motivation of the PMLN-PPP is partly to preserve their immunity from prosecution under numerous ongoing anti-corruption investigations and legal cases.

But the unwillingness to remove the populist fuel and energy subsidies introduced by the PTI, the efforts, albeit futile, to secure bilateral financial assistance from, at least, Saudi and the UAE, and the policy to slow down the introduction of electronic voting machines and voting by overseas Pakistanis (changes which would likely favour the PTI), suggest that the PMLN-PPP have ambitions beyond self-preservation.

These are the actions of politicians who want to run government, not merely evade prosecution. However, this violent crackdown likely makes realising those ambitions even harder.

Military-intelligence deep state

The military-intelligence deep-state has thus far, at the time of writing, remained silent.

Two of the sub-plots around the fall of the PTI government:

  1. Uncertainty over whether then PM Khan was willing to endorse Chief of Army Staff Bajwa for a third consecutive 3-year term in November 2022.

  2. To what degree the National Security Committee, of which Bajwa is a member alongside the other military heads and civilian government leaders, endorsed the US interference claims hinted at the time by then PM Khan.

From the outside it is not clear whether Bajwa still wants a third term, whether the deep state is united, and what their red line is for intervention, and what is the nature of that intervention, eg a mix of a private and public arbiter, as played by former army chief Raheel Sharif during the 2014 PTI protests against the then PMLN government, or something more overtly interventionist in the manner of martial law eras?

Martial law still seems a remote possibility: while the political and economic risks are acute, the military-intelligence deep state has worked out, from multiple historic experiences, that martial law is counter-productive: the army loses popularity (and that was in an era which pre-dates social media's ubiquitous flow of real and fake news and views), promotion within the senior cadre of officers is throttled, and international economic and diplomatic engagement is made much more difficult.

Economic and markets implications

Heading towards a crisis

Given Pakistan’s limited reserve buffers (under two months import cover) and large external financing needs, resumption of its IMF programme is necessary to avoid a balance of payments crisis. This week's IMF statement makes it clear that removal of fuel subsidies is a necessary precondition for programme resumption, which may be a difficult proposition for the new government given the difficult political backdrop.

This week’s 150bps rate hike (up to 13.75% compared to the last inflation reading of 13.45%) and recent rupee weakness (down 12% ytd) will reduce imports and buy the government some time to avert a BOP crisis, but ultimately fiscal consolidation is required to prevent the economy from overheating and resumption of the IMF programme is necessary to unlock the funds needed to plug Pakistan’s external financing gap.

Eurobond and Equity values may already reflect this crisis

2031 Eurobond - Retain Buy recommendation

With yields on Pakistan’s 2031 Eurobond near 15% and prices in the low- to mid-60s, the risks are now largely priced in.

Default risk stems primarily from liquidity rather than solvency issues, with public debt below 75% of GDP. This means that recovery values could be near or above current prices, with any potential restructuring likely to focus on cashflow relief rather than large nominal haircuts.

Against this backdrop, we see upside to Pakistan's eurobonds at current prices and retain our Buy recommendation on the PKSTAN 7 ⅜ 04/08/2031s at 14.66% (US$64.46) as of cob on 25 May on Bloomberg.

Equities – Cheapest in EM and FM

The KSE 100 index is down 18% ytd and 31% in the last 12 months, compared to MSCI FM down 16% and 7%, respectively, as of cob 25 May.

Pakistan equities are already about the cheapest in all emerging and frontier markets, when judged by trailing PB and PE multiple discounts relative to 5-year median.

  • Trailing PB is 0.7x (alongside 20% ROE), a 40% discount to the 5-year median.

  • Trailing PE is 4.3x, a 55% discount to the 5-year median.

  • Consensus forward 2023e PE is 3.7x (alongside 2023e 11% dividend yield and 2023e earnings growth of 10%).

  • A reversion to a REER of 100 or to the 10-year median REER would imply FX rate appreciation of c10%.

There are currently no capital controls or FX repatriation restrictions facing foreign institutional investors that we are aware of.

Pakistan is the cheapest equity market in Asia EM