Macro Analysis /

Pakistan: IMF programme sets out major structural and fiscal reforms

    Saad Ali
    Saad Ali

    Head of Research

    Intermarket Securities
    9 July 2019

    As per IMF staff report for the US$6.0bn EFF program, Pakistan will receive the first tranche of US$1.0bn immediately. For subsequent disbursements – which will be quarterly in the first year, but semi-annual thereafter – Pakistan will have to fulfill certain benchmarks (details below). This follows the fulfillment of prior actions since the conclusion of the staff-level agreement in May. These include the announcement of the FY 20 Budget with tighter fiscal measures, 150bps increase in interest rates and adoption of market-determined exchange rate regime (PKR has slipped 7% since May) in addition to large upfront increases in power and gas tariffs.  

    For the 39-month EFF programme, key measures agreed between the IMF and Pakistani authorities are listed below. We also include the takeaways from the meeting with State Bank of Pakistan (SBP) Governor Reza Baqir, which was held today, to shed light on the terms laid out in the report.

    Monetary policy: Authorities have agreed to maintain an adequately tight monetary policy in order to avoid further deterioration of the external account and undue pressure on the currency. IMF projects inflation to average 13% during FY 20f while the SBP is required to keep the real policy rate positive. As such, the Bank will likely increase policy rate further (from 12.25% presently) in the July MPS, in our view. As per the SBP, the MPC will base future monetary policies on the inflationary outlook for 1-2 years. 

    External account: Importantly, the IMF acknowledges that the bilateral and multilateral arrangements (cumulative US$17.5bn) that Pakistan has availed prior to its entry into the programme are sufficient for the next 12 months; therefore, the IMF forecasts SBP’s FX reserves to build up by cUS$4.0bn until June 2020 (from US$7.2bn presently). On the external account, the IMF contends that further improvement in current account deficit (CAD) is pertinent. However, Pakistani authorities have agreed to eliminate the existing regulatory duties on luxury-item imports and other administrative restrictions during the program. 

    Exchange rate: The SBP has adopted a market-based exchange rate regime, where it will limit interventions only to allay disorderly market conditions. The SBP highlighted that recent PKR depreciation has been effective in containing CAD (from 6.3% of GDP in FY 18 to 4.6% in FY 19 amid a cumulative 33% PKR devaluation). The Bank highlighted that excluding oil imports, Pakistan has already overcome its current account deficit. During FY 20f, the commencement of the Saudi-deferred oil payment arrangement will further ease BoP pressures. All else the same, this should serve to reduce the present volatility in the exchange rate, in our view.

    Fiscal policy: The IMF commended the measures set out in the FY 20 Federal Budget, which will help contain the primary deficit close to the target of 0.6% of GDP. Pakistan will aim for improvement of tax/GDP ratio by 4-5ppts over the medium term, through a major overhaul of the tax system. These include: (i) removal of tax exemptions and preferential treatment (prior action), and (ii) having the provinces improve tax collection from real estate, agriculture and services sectors. The authorities have also agreed to not undertake another tax amnesty. The provinces have agreed to deliver surplus of 1% of GDP (2.7% by the end of the programme term). Additionally, the government will discontinue borrowing from the SBP (which was inflationary) and re-profile the maturity of its domestic debt (from commercial banks) to longer tenure than 3-6mths. 

    Energy sector: Pakistani authorities have agreed to implement deep structural reforms in the energy sector, particularly to arrest the buildup of circular debt. Most prominent changes will be (i) automatic determination of change in power tariff on a quarterly basis, (ii) prompt adoption of new gas tariffs from July, (iii) planning for reduction of system losses in gas distribution (end-September), and (iv) future unbundling of the two gas utilities. In addition, the authorities are required to submit detailed schedule for future power tariff increases, and chalk out quarterly targets for reduction of circular debt. The life-line power consumers (<300Kwh per month) will be guarded against annual tariff increases.

    Banking sector: Two key measures. Firstly, the SBP has to ensure all banks are well-capitalised and promote M&A activities within undercapitalised small banks. Secondly, authorities have also agreed to the establishment of a treasury single account (TSA).

    Privatisation of SOEs: Pakistani authorities have agreed to undertake the following privatisations near-term: (i) two RLNG-based power plant, (ii) two real-estate properties in Lahore and Islamabad, (iii) two specialised banks (SME Bank and First Women Bank) , and (iv) GoP residual stake of 18.39% in Mari Petroleum. As a structural benchmark (end-September 2020), Pakistan will have to submit a list of SOEs and the role (ownership and regulatory) that it plans to undertake with each entity. We think this will map out the entities Pakistan will need to privatise during the programme. 

    In light of the IMF report and the meeting with the SBP Governor, we think Pakistan is moving in the right direction to considerably reduce its twin deficits to more sustainable levels by the end of FY 20. This could potentially mean further macro adjustments would be limited. However, the inflationary trajectory from here on, and timely delivery of the fiscal reforms committed by the authorities will be key determinants for future policy direction, in our view.