Macro Analysis /

Pakistan: IMF programme details point to greater fiscal tightening

  • IMF has set six new targets for fiscal and structural reforms, some of which can be tough to implement

  • New tax measures have been penciled in for the upcoming FY23 Budget, including some skipped in the Mini Budget

  • Moderately negative implications for Fertilizer, Textile, Tractors but very positive for Energy sectors

Pakistan: IMF programme details point to greater fiscal tightening
Intermarket Securities
7 February 2022

As per the IMF Article IV Consultation report, Pakistan has to deliver more fiscal and structural targets until the end of the EFF Program by September 2022 (six new structural benchmarks). Additional tax measures – including some which were skipped in the recently passed Mini Budget – have been penciled in for the FY23 Budget by the government (details below). Some of these measures worsen outlook for inflation, which has already been around 11-13% in recent months.

On the positive side, however, Pakistan is set to receive another US$3bn from the IMF until September (upon fulfillment of new SBs), in addition to significant external flows committed by bilateral and multilateral sources.

Tax measures: FY23 Budget Preview

The government will reform the personal income tax structure (PIT), by reducing tax slabs and credits, on top of expanding the tax net. A PIT legislation will come into effect under the next Federal Budget (new SB for February 2022).

The government has agreed to remove tax exemptions on fertilizer and tractors – which were skipped in the Mini Budget – bring GST on them to 17% (from 2-5% presently) but offsetting the price impact on farmers through fresh subsidies. We think that this will be broadly neutral; as both industries will be able to pass on the increase in GST, and demand will be protected by new subsidies. However, if the subsidy mechanism is not efficient, it could potentially impact tractor sales (negative for MTL and AGTL). In the past, higher GST on tractors, not matched by commensurate subsidies, has been seen to significantly dampen tractor sales.  

Monetary policy: Adopt a data-driven policy

The IMF has recommended that the SBP continue to determine monetary policy based on forward looking data, without directly hinting that more interest rate hikes are needed in the near future, in our view. At present, interest rates are “broadly neutral from a 12 month forward basis.”

The IMF has recommended that the SBP unwind refinancing facilities (concessionary borrowing largely availed by exporters) and establish a new Development Financial Institution to do the same (a new SB for end-April 2022). As per our discussions with certain exporters, the government has increased the rates on these facilities in the past (not a very worrisome measure in the short term), and the guideline does not seem to affect the more important long term financing facilities (LTFF).  

It has dissuaded from excessive SBP intervention in the currency market and pushed for withdrawing restrictions on exchange companies and cash-margin requirements for importers, once the balance of payment situation is more stable.    

The IMF has also discouraged from pushing commercial banks for housing finance, to avoid misallocation of credit, and instating amnesties for construction companies. If implemented, this is likely to dampen construction activity and demand for materials beyond FY22, in our view.

The IMF has required the completion of first stage of recapitalization of two private banks (a new SB for end-May).

Energy sector reforms: Tariff hikes and circular debt reduction

The government will increase the base power tariff again by February. Pakistan has already increased the base tariff by a cumulative PKR3.34/kWh (by c.25%) since January 2021; we think another PKR1.5-2.0/kWh (by c.9-12%) is likely which by itself is estimated to increase inflation by 0.5ppt. Note that an increase in gas tariff is also on the cards. 

The government will aim to privatize two RLNG based power plants by end-June 2022 and use the proceeds partially to reduce the balance of outstanding circular debt. Reportedly Qatari investors are interested in buying the plants for around US$2.0bn (c.PKR350bn). Circular debt balance stood at PKR2.47tn by end-December 2021 (c.5% of GDP).

In order to ensure full cost recovery through timely OGRA notifications, the government will pass the OGRA Act in the Parliament by June 2022 (a SB). In our view, this will be a long-term positive for the Energy sector (particularly fuel suppliers), as it will make the cost recovery process more nimble, but could disarm the government from the ability to contain increase in consumer fuel prices to moderate inflation.

The government has already adopted the second step of energy subsidy reform for residential consumers in December 2021 (a new SB for Jan 2022), which will limit power subsidies to the most vulnerable consumers.

Structural reforms: Legislation for SOE transformation

The IMF has required the parliamentary approval of SOE law until June 2022 (new SB), which will develop a framework for better governance and oversight of SOEs, in order to reduce their losses and in turn the fiscal burden they entail. Since, like the amended SBP Act, this law will pass through both houses of Parliament (PTI lacks majority in the Senate), it will likely be another uphill task for the incumbent government.

All in all, the new measures required by the IMF – additional tax measures and new structural targets such as the SOE law and OGRA Act – will be tough to achieve for the government, in our view.  Nonetheless, we reiterate that the resumption of IMF program ensures balance of payment stability of Pakistan and continued commitment to reforms until the end of the present government’s term.

Key sectors for which there are some negative implications, include Fertilizer, Tractors and Textiles, albeit any earnings impact will be moderate for these industries, in our view. On the other hand, the continuation of IMF Program is a big boost for the entire Energy sector, as it promises measures that can stall circular debt buildup in the medium term. Thus, it should serve to revive stock price performance of OGDC, PPL, PSO, HUBC and gas utilities, all else the same.