Change is often tough, but necessary
Pakistan has resumed its IMF program, earlier put on hold due to Covid-19, and the third tranche of US$500mn has been recently released. As part of the conditions, Pakistan has had to remove certain income tax exemptions and amend the SBP Act. The removal of income tax exemptions reportedly amounts to a modest PKR140bn (c.0.3% of GDP), and appears to have been absorbed by the market. However, the proposed changes to the SBP Act are being a source of consternation, with several articles in the media raising alarm. The SBP Governor has made a welcome media appearance to dispel some of these concerns, but we believe that this needs to be followed up with more communication from the central bank. In this regard, although the overnight replacement of the de facto Finance Minister Dr. Abdul Hafeez Shaikh with Mr. Hammad Azhar may have been in the works after the former’s surprise loss in the Senate elections, it is possible that media criticism over the proposed SBP Act acted as a final straw.
Key proposed changes in the SBP Act
The primary objective will be focus on domestic price stability
No new government borrowing from the State Bank of Pakistan
SBP to significantly limit its quasi-fiscal operations
Longer terms for SBP officers, alongside protection from government agencies
Major revisions to the SBP Act have occurred in the late 1990s and the mid-2010s, the last in 2015. None, as far as we can recall, sparked much debate. The proposed SBP Amendment Act 2021 is different, with some economists even terming it detrimental to Pakistan’s sovereignty. We believe that the provision for no new government borrowing from the central bank (as opposed to the current regime of zero net borrowing on a quarterly basis) is the single most important point that the media is baulking over. The table below summarizes our thoughts on the key proposed changes.
View for the market
Pakistan’s economy has stabilized and is embarking on growth again. The growth has proven to be fleeting in the past and in this context, it is important that the reform process is not derailed. Although the removal of Dr. Shaikh may seem to suggest otherwise, the quick resumption of the IMF program indicates the government is cognizant of the need to continue with reforms and is not easily giving in to populist impulses. The new Finance Minister Mr. Hammad Azhar, a graduate in development economics from the SOAS London, joined the PTI in 2011 and has gradually built a reputation as a steady hand as the Minister for Economic Affairs and later as the Minister for Industries & Production. Mr. Azhar also led Pakistan’s effort to become compliant with FATF requirements, which has seen significant progress and for which he has won much praise.
Going forward, while some reforms will be difficult and there will be pushback (as seen around the proposed SBP Act), sustainable positives can emerge over the medium to long term under Pakistan’s more disciplined macroeconomic approach, which should unlock greater valuation rerating for the KSE-100 (FY22f P/E is 5.6x vs. the long-term average of 9.0x). From this vantage, the proposed changes to the SBP Act are welcome. However, the SBP needs to be more open in its communication, and there also needs to be provision for policy flexibility in case some of the proposed changes prove to be a case of too much, too soon. We remain positive on Pakistan equities and believe the ongoing reform theme remains intact, which merits more attention from foreign investors in particular.