Macro Analysis /

New IMF program to effect a tough FY20 Budget, but policy clarity is a much-needed positive

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Intermarket Securities
    13 May 2019

    The IMF has reached a staff-level agreement with Pakistan for a 39-month Extended Fund Facility amounting to about US$6bn. This economic plan will now be presented to the IMF’s management and Executive Board, subject to the implementation of prior actions by Pakistan. Reportedly, the program will likely be complemented by US$2-3bn from other multilateral agencies, resulting in an effective program size much higher than US$6bn.          

    Some of the policy actions Pakistan may take ahead of program entry could include:

    • A further increase in interest rates. That said, given that a 500bps hike has already taken place in this cycle, and that real interest rates stand between +2.0 and +2.5% (measured against the April CPI reading), we believe further rate hikes may be relatively moderate, in the 100bps-200bps range.  
    • More PKR depreciation, possibly by 5-10%. Even though the IMF has indicated its desire for a “market-determined exchange rate”, we think this could effectively mean net zero intervention by the SBP on an annual basis (intervention may still take place selectively e.g. when large oil payments are due). Similar to our thoughts on interest rates, we do not see the need for a very large adjustment to the PKR given: (i) the PKR has already depreciated by 25%+ vs. the US$; (ii) the REER has been driven down to 104; and (iii) the 1QCY19 current account deficit has annualized to a manageable 2.3% of GDP. Beyond the immediate-term, we believe PKR depreciation is likely to take place gradually, in contrast to the step-ladder pattern of the past.  
    • Deep fiscal tightening, with the IMF hoping to see the primary deficit restricted to 0.6% of GDP in the upcoming FY20 Budget. This will take place through a combination of revenue generation (higher GST) and administrative measures (reduced exemptions) under the new FBR Chairman, as well as cost recovery via a phased increase in power tariffs. The development budget could also see a reduction, although essential spending will not be compromised. Interestingly, the IMF has flagged the improved running of public enterprises as a priority area, rather than a clear push for a privatization program. The IMF has also pointed towards the need for improved revenue distribution between the centre and the provinces, but we continue to believe this will be politically difficult. As with prior periods of economic consolidation, GDP growth will likely only gradually increase from a c 3% reading in 2019f. 

    The upcoming IMF program will usher in the last phase of economic belt-tightening that has been in place over the last eighteen months. However, it may also provide a foothold to the equity market, by providing policy clarity and encouraging more foreign investors to return (net year-to-date FPI inflow stands at c US$45mn). Valuations are supportive of a market rebound, with Pakistan trading at a 2019f P/E of 7.2x vs. a cross-cycle average of about 9.0x. The 2020f P/E of 6.1x is even more appealing, driven by a robust earnings growth outlook for the Banking sector, which has a c.27% weight in the KSE-100 index.