Macro Analysis /

Pakistan IMF Review: So far so good

    Intermarket Securities
    26 December 2019

    Pakistan’s program has over-performed on a number of fronts but risks remain

    • In its staff-level report on the First Review of the US$6.0bn Extended Funds Facility (EFF), the IMF has remarked that Pakistan’s economic reforms program has had a strong start (underpinned by the smooth transition to a market-determined exchange rate), and is on track to address large imbalances and achieve stability during the course of the program. The review paved the way for the release of the second tranche of US$453mn, taking the total disbursements under the program to c US$1.4bn. In our view, with the government appearing steadfast on its economic reforms agenda, under close monitoring by the IMF, Pakistan’s macroeconomic metrics should gradually transition from a stabilization phase into a growth phase over the next 1-2 years, which should be supportive of further valuation rerating at the KSE-100.  Risks emanate from (i) the significant fiscal adjustment that is still needed, (ii) any backtracking on policy commitments, and (iii) potential FATF blacklisting, in our view.   

    Key takeaways from Program Performance in 1QFY20 include:

    • Pakistan met all September 2019 and continuous performance criteria (PCs). Five indicative targets (ITs) were missed, including containing tax refund arrears and power sector arrears, but Pakistan is on track to complete them by end-December.
    • Pakistan's tax revenue in 1QFY20 rose 17%yoy, with 25%yoy growth in the domestic component of tax revenue, balanced by a modest 7%yoy rise in import-based taxes (which has been about 40% of total tax revenue). Importantly, a primary surplus of 0.6% of GDP was recorded in 1QFY20, with the overall budget deficit also coming in better than programmed. 
    • IMF projects GDP growth of 2.4% for FY20, 3.0% in FY21, and 4.5-5.0% over the medium term. Inflation is expected at 11.8% in FY20, and IMF aligns with SBP's view of a medium-term range of 5-7%.

    Fiscal measures: A mini Budget on the cards?

    • FBR's revenue target for FY20 has been cut from PKR5.50 trillion to PKR5.23 trillion.  
    • Authorities will present a mid-year budget review report by the end of February 2020 and take any corrective measures if needed (new criteria).
    • IMF has encouraged greater development spending to spur growth, including an allocation of PKR20-30bn in FY20 to scale up the Ehsaas affordable housing program. An amount of PKR10bn has also been earmarked for subsidized financing to exporting sectors, and the government will buy back PKR30bn of promissory notes issued to exporters (related to outstanding rebates and tax refunds).
    • Authorities have agreed to refrain from issuing new preferential tax treatments or exemptions (a new criteria). 
    • IMF highlights the risk that the PTI-led government lacks a majority in the Senate, which may obstruct the legislation needed to implement some reforms.

    Comments: There is a hint towards a mini-Budget in late 3QFY20 or 4QFY20 despite a reduction in the total revenue target. Given the FY21 Budget is expected to be announced in May-June 2020, it is possible that only the most important and quick-fixes are implemented via a mini-budget, if needed. In our view, these could include measures such as increasing taxes on petroleum products and selected imports, and increased FED on goods such as cement, cigarettes etc. Such measures will be inflationary and could negatively impact inflation outlook and in turn monetary policy.

    Monetary policy: To remain tight until disinflation is entrenched

    • The IMF staff and SBP have agreed that "monetary policy stance… should remain tight, until inflation shows a clear declining trend."
    • In order to enhance SBP's autonomy, amendments to the SBP Act will be forwarded by SBP to the Finance Ministry by end-January 2020 and submitted to Parliament by end-March 2020. Changes will include (i) establishing SBP's primary objective being domestic price stability, and (ii) ultimate removal of quasi-fiscal operations.

    Comments: There is a risk that unless inflation from December 2019 to February 2020 shows a consistent declining trend, the SBP could delay the first cut in policy rate beyond March 2020. We continue to expect the first cut in March.

    External account: Positive tidings

    • "The exchange rate overvaluation has been corrected….The program remains fully financed for the next 12 months and with good prospects for the remainder of the program."
    • Committed bilateral and multilateral flows include: China US$5.2bn, Saudi Arabia US$6.2bn, UAE US$1.0bn, World Bank US$1.7bn, ADB US$2.5bn and Islamic Development Bank US$1.1bn.

    Comments: IMF has reiterated that Pakistan has arranged adequate inflows for the expected external outflows for FY20. The IMF forecasts SBP's Fx reserves by end of FY20 and FY21 at US$11.2bn and US$14.9bn respectively (currently, the SBP's Fx reserves are nearing US$11bn).

    Energy sector reforms: Push on privatization… again

    • The IMF has set out a comprehensive plan for the government to contain the circular debt buildup to PKR50-75bn per annum by FY23 (from about PKR10bn per month rate presently), which will include the timely revision of tariffs, among other measures. The government targets zero buildup. IMF has thus allowed issuing new government guarantees of PKR200bn for reducing outstanding arrears. Also, outstanding arrears will be settled partly through privatization proceeds of power sector assets.
    • Gas tariff increases in July 2019 and an upcoming increase by end-December 2019 will be a key measure to address circular debt buildup in the gas chain.
    • Authorities have indicated that they will finalize the privatization of two LNG based power plants by end-FY20. 

    Comments: The second Sukuk issue for the power sector appears to have been allowed. We can expect about US$2.0bn from the sale of the power plants. Another gas tariff hike is indicated (recall that OGRA has recently recommended 32% or more increase in consumer tariffs by January 2020).


    • IMF remarked that faster progress is need on the measures related to addressing anti-money laundering and terrorism financing. The IMF will provide technical assistance in this regard. 
    • The government has initiated work on introducing single treasury account (TSA-1) by end-September 2020. 
    • There is a plan to establish a new semi-independent national tax authority that will facilitate closer coordination between the federal government and the provinces.