Macro Analysis /

Pakistan Economy: Changes to State Bank and tax revenue personnel aim for credibility with IMF

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Intermarket Securities
    6 May 2019

    More changes to the top economic leadership have taken place over the weekend, following the appointment of a new finance minister last month. SBP Governor Mr Tariq Bajwa has been replaced by Dr Reza Baqir, hitherto the IMF's senior resident representative in Egypt. The other change is at the FBR, with the outgoing Chairman Mr Jehanzeb Khan to reportedly be replaced by Dr Ahmed Mujtaba Memon, currently with the Finance Ministry.   

    Pakistan is at the cusp of entering a new IMF program, and the change at the FBR highlights the priority being assigned to tax reform, in the backdrop of a large fiscal deficit (FY18: 6.6% of GDP). In 10MFY19, tax collection has reportedly grown by just c 2%yoy and the tax-to-GDP ratio has fallen to less than 10% (based on FBR collections only). The incoming FBR Chairman will likely face tough tax collection targets, but also significant backing to achieve these targets. 

    The change at the SBP is less obvious. Under Mr Bajwa, appointed in July 2017 by the PML-N, interest rates increased by 500bps starting from January 2018, while the PKR depreciated by more than 25% vs. the US$. Such contractionary measures will likely extend under the new Governor. With the appointment of Dr Baqir, however, the central bank's top leadership has reverted to type i.e. a formally trained economist, usually associated with global multilateral agencies, with due focus on SBP independence. Between 1993 and 2009, all three SBP Governors were previously associated with one of the IMF, WB and ADB. 

    We continue to see ongoing staff-level talks with the IMF quickly transitioning into a new IMF program. However, it is possible that local investors view Dr. Baqir's time in Egypt - which coincided with an IMF program in that country - with some trepidation. IMF program entry in Egypt in 2016 led to the Egyptian Pound slipping by c 50% vs. the US$ in the span of a few weeks, with inflation more than doubling to 23.5% in 2017 and interest rates crossing 19% at peak. This transitory pain, however, is now leading to a sustainably stronger economy (as per the IMF, Egypt’s June 2019 CPI is projected at c 11%, fiscal deficit at 7.9% of GDP, a 9yr low, and current account deficit at 2.5% of GDP). Investors are also taking note - in 2019td, the EGX 30 is up 11.8%, with a return CAGR of c 20% (in local currency) since Egypt submitted its Letter of Intent to the IMF.

    We highlight that Pakistan's economic situation appears significantly better compared to Egypt in 2016, which saw the fiscal deficit hit 12.5% of GDP, and currency moving from a tightly managed float to market-based determination (10 yr depreciation CAGR of just c 4% for the EGP before this shift). In Pakistan's case, the tightening measures taken over the previous 15 months are already having an effect (e.g. the current account deficit has reduced to an annualized 2.3% of GDP in January-March 2019 vs. 5.8% of GDP in FY18). As a result, we retain our view that further adjustments to interest and exchange rates in Pakistan are likely to be relatively moderate (unless there is a major shift in inflationary outlook), and not akin to the "Egypt model" in quantum. 

    The KSE-100 has continued to lose ground, shedding 4.8% in April to turn negative for the year. It is possible that the market continues to trend lower in the near-term but, with 2019f P/E now at 7.5x (2020f: 6.5x) vs. a cross-cycle mean of 9.0x, we think further downside is limited. We continue to eye entry into an IMF program as a key trigger and reiterate our buy-on-dips call. Banks look particularly attractive, especially after their strong earnings beat in 1Q19.