We hosted a call earlier this week with the State Bank of Pakistan (SBP). Attendees included Deputy Governor Dr Murtaza Syed, Executive Director Mr Muhammad Ali Malik, and Director of the Governor’s Office Mr Amin Lodhi. The SBP’s presentation can be viewed by clicking on the “Download full report" button (available to Tellimer Insights Pro clients), and we summarise our thoughts below (views are our own). We would like to thank the SBP team for their time and insights.
As we have outlined before (see 'Related reading', below), Pakistan’s economy has followed a three-phased arc over the past few years: 1) the commencement of an IMF-backed reform programme to address external and fiscal imbalances in mid-2019; 2) a calibrated economic response to Covid, leading to some slippage from IMF targets; and 3) a strong recovery amid a shift from stabilisation to growth and a vastly improved balance of payments (BOP).
More recently, however, we have expressed concerns about rising external vulnerabilities amid signs that the economy may be running a bit too hot, leading to a sharp currency selloff. And indeed, the SBP has now shifted its focus from growth back to stabilisation, starting with a 25bps rate hike last month following cumulative cuts of 625bps and stimulus totalling 5% of GDP post-Covid.
Although much of the recent rise in inflation and imports is still assessed to be transitory, high domestic demand is also a factor. And, while inflation expectations appear well-anchored, the SBP stands ready to act if price pressures persist. With a proactive policy response and the flexible exchange rate now serving as a shock absorber, the SBP seems confident that BOP pressures can also be contained.
With growth expected to rebound to c5% in FY 21/22 and the output gap expected to close by the end of the year, the policy bias has now clearly shifted towards gradual tightening to make sure the recovery is sustained and reserves (which have fallen to US$17.1bn from US$20.1bn at the end of August) remain sufficiently high.
Perhaps most important for markets, the SBP also seems confident that the IMF programme will be put back on track soon. While external financing remains ample to fund Pakistan’s BOP (with plans to issue a Sukuk in the near term and return to the eurobond market over the medium term), any IMF disbursements and additional funding that it catalyses will help minimise the risk of a gap emerging.
Indeed, headlines that the government was close to reaching an agreement with the IMF for its next programme review and that US$4.2bn of additional financing has been secured from Saudi Arabia to boost reserves and finance oil imports have sent eurobond yields plummeting, with the PKSTAN 7 ⅜ 04/08/2031 mid-YTM falling below 7.2% from nearly 7.9% in mid-October and prices rising 4.7pts (4.9%).
Pakistan’s reform story remains solid, with the government exceeding most headline IMF targets, the budget deficit and debt both declining post-Covid, and the shift to a flexible exchange rate contributing to a vastly improved BOP. However, as we previously highlighted, the restoration of Pakistan’s IMF programme is necessary, in our view, to backstop the government’s reform agenda and preserve BOP improvements by unlocking cheaper and more sustainable sources of funding.
Against this backdrop, we have said that we would consider an upward review of our Hold recommendation on Pakistan’s eurobonds if the IMF programme was put back on track. Unfortunately, we were a bit slow to the punch with our upgrade and have missed the near 5% rally since news emerged of the potential IMF agreement. As such, we think the upside has now been largely priced in, and maintain our Hold recommendation on Pakistan’s eurobonds.
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