Nearly four-and-a-half months after the seventh and one-and-a-half months after the eighth reviews of Pakistan’s IMF extended fund facility (ECF) were due to conclude, the country has finally reached staff-level agreement on policies to complete them. Subject to Executive Board approval, this would pave the way for a US$1,177mn disbursement (bringing total disbursements so far to US$4.2bn). The programme will also be extended from September 2022 to June 2023, and available financing increased by SDR720mn (cUS$950mn).
The reviews were completed after the delayed implementation of numerous prior actions in recent weeks, including:
Reduction of gas and power subsidies, with previous failures to do so contributing to power outages and pushing circular debt in the power sector to PKR850bn (cUS$4bn) in FY 22;
Tightening monetary policy and linking the government’s refinancing schemes to the policy rate;
A commitment to greater exchange rate flexibility;
Expanding unconditional cash transfers; and
Strengthening governance and anti-corruption efforts.
As we have stated repeatedly (see related reading, below), resumption of the IMF programme is necessary to avoid a balance of payments crisis. With a widely cited US$41bn gross external financing requirement in FY 23 (ie the one that started this month) versus liquid FX reserves of just US$10.3bn (just 1.5 months of trailing goods & services imports), Pakistan will need to rely on a large external financing pipeline to prevent a further drawdown of reserves. Perhaps most encouragingly, the IMF’s staff-level agreement is a tacit recognition that Pakistan’s financing pipeline is sufficient, as the Fund is prohibited from lending to countries with an external financing gap that cannot be covered under programme parameters.
That said, Pakistan is not out of the woods yet, with Board approval still necessary to get the programme fully back on track. Indeed, with the spread on the PKSTAN 7 ⅜ 04/08/2031s rising by 10bps on the day, markets still seem to be circumspect that the programme will be resumed, and/or if it is resumed may be worried about future slippages that could cause it to be derailed again (the current programme has already fallen off track twice, with substantial delays to the second, third and fourth reviews, and only the first and sixth reviews having been completed on time).
There is certainly some merit to this caution given Pakistan’s weak track record with the Fund and a political backdrop that will make reform implementation difficult, but the lack of any discernible positive reaction is a bit perplexing (and possibly reflective of the broader risk-off sentiment in addition to Pakistan-specific factors). With the PKSTAN 7 ⅜ 04/08/2031s now trading below our base case recovery value of US$59 and just above our bear case of US$53, based on our June analysis and 12% exit yields, the risk of default is now fully priced in, in our view, with substantial upside if Pakistan is able to stick to its reform promises.
That said, the upside is capped by a weaker longer-term reform outlook – see below – which makes it unlikely that yields will reach the lows of c500bps last year (versus nearly 1,500bps today). However, with bonds trading in line with recovery value and Pakistan taking a significant step towards restoring its IMF programme and unlocking the external funding needed to avoid a balance of payments (BOP) crisis, we are strengthened in our conviction that Pakistan’s eurobonds offer compelling value and affirm our Buy recommendation at US$55 (17.65% YTM) for the PKSTAN 7 ⅜ 04/08/2031s as of cob on 13 July on Bloomberg.
Equities valuation reflects much concern already
Pakistan equities are now down 21% ytd in US$ total return terms, compared with down c14% for Bangladesh and India.
Pakistan equity valuation is among the cheapest in Asia EM:
Trailing PB of 0.8x (for ROE of 20%) is a 30% discount to the five-year median;
Forward 2022f PE is 3.9x (for 21% earnings growth and 10% dividend yield, on current consensus forecasts), a c45% discount to the five-year median; and
In the short term, the combination of moderating global oil and food inflation and the resumption of the IMF loan should act as positive catalysts for the equities.
However, in the long term, the agenda of structural reform governance, including widening of the tax net, root and branch reform of state-owned enterprises, and effective accountability of the civilian and military leadership, has evaporated with the demise of the Imran Khan-led PTI government.
Even if mass protests, voter mobilisation and a repair of his relationship with the military leadership does lead to an ultimate return to civilian leadership, the speed and ease with which his government was terminated earlier this year demonstrates the vulnerability of any future administration with the same reformist agenda.
Pakistan: Rising inflation prompts much-needed rate hike, July 2022 (Curran)
Pakistan: DSA and restructuring analysis shows bonds are near recovery value, June 2022 (Curran)
Pakistan: Crackdown on protests and IMF talks futile, but value reflects crisis, May 2022 (Malik & Curran)
Pakistan: Rate hike provides breathing room but not enough on its own, May 2022 (Curran)
Pakistan shows signs of progress on IMF programme, April 2022 (Curran & Malik)
Imran Khan is out as old parties prevail, for now, April 2022 (Malik & Curran)
Our discussion with the State Bank of Pakistan, April 2022 (Curran)
Pakistan hikes rates as political crisis reaches a crescendo, April 2022 (Curran & Malik)
Pakistan’s early elections are positive for Imran’s PTI and investors, April 2022 (Malik & Curran)
Pakistan’s no-confidence vote: Last stand for the opposition, not Imran Khan, March 2022 (Malik & Curran)
Pakistan’s Eurobonds collapse on rising risk, but may have overshot fundamentals, March 2022 (Curran)
Pakistan: Underperformance unjustified, but risks remain high, January 2022 (Curran)
Pakistan: Upgrade to Buy after positive IMF review and policy shift, November 2021 (Curran & Malik)
State Bank of Pakistan provides rosy economic outlook, November 2021 (Curran)
Pakistan’s currency crash in charts, October 2021 (Curran)
Pakistan: External risks to rise if IMF programme cannot be secured, August 2025 (Curran & Malik)
Pakistan: Budget solidifies shift from stabilisation to growth, June 2021 (Curran)