Strategy Note /

Pakistan: IMF deal is necessary despite help from friends

    Christopher Dielmann CFA
    Christopher Dielmann CFA

    Director, Macroeconomic & Sovereign Research

    Hasnain Malik
    Hasnain Malik

    Strategy & Head of Equity Research

    Tellimer Research
    20 January 2019
    Published by

    An IMF deal would propel Pakistan to our favourite equity market. But we cannot be certain the deal happens and, therefore, reiterate our neutral views on Pakistan US$ sovereign bonds and local equities. 

    IMF deal would do more to dispel FX rate concerns than help from friends. With an IMF deal, near-term concerns over balance of payments (FX rate, FX repatriation) and policy credibility (fiscal deficit) should be quickly dispelled and reopen the gates to foreign investor inflows (rebuilding FX reserves from critically low levels and, potentially, re-rating equities upwards). Without an IMF deal, the cUS$14bn of balance of payments support (cash deposits, deferred payments for oil imports) secured from geopolitical supporters (Saudi, UAE and China) and the windfall of (at least, for now) lower oil prices, are likely to be sufficient to muddle through 2019 at least. But under this scenario, concerns about another balance of payments crunch in 2020 will persist, likely keeps foreign portfolio and direct investment on the sidelines. There are echoes of Egypt in 2013, when GCC allies provided ad hoc support but difficult structural reforms (fiscal cuts, devaluation) were put off, FDI pledges were not converted into deployments and GCC support eroded after the oil price crashed; all ultimately resulting in the FX crisis of 2016. In this scenario, any equity re-rating would have to be driven by local investors. Foreigners have been net sellers in each of the past four years, in an accelerating manner. 

    The new PTI government has adopted more orthodox macro policy than some feared, but it may not yet have gone far enough for the IMF. Contrary to the fears of some, the PTI government, formed after the July 2018 election, has acted in an entirely orthodox manner in response to its inheritance of critically low FX reserves, widening twin deficits, accelerating inflation and slowing growth. It has made fiscal cuts, raised interest rates and devalued the FX rate. More fiscal tightening and a credible commitment on the timetable for privatisation of loss-making, state-owned enterprises are potential sticking points in ongoing negotiations with the IMF. Although fiscal cuts are politically unpopular, the PTI commands a parliamentary majority and there are still over four years before the next election (and, arguably more importantly, the other established parties are at risk of fragmentation because of the intense anti-corruption scrutiny of their leadership). This may allow for greater fiscal cuts than seen so far (a second post-election, interim budget is due on 23 January). On privatisation, the PTI has historically advocated reform while these entities are still in the public sector, before privatisation; i.e. first deal with the root law enforcement, anti-corruption and governance causes of, for example, politically-motivated management appointments, ghost workers, utility network theft and non-payment of bills. Given the failure of several previous governments to follow through on privatisation commitments to the IMF (and the IMF highlighting this specific failure in its review of the 2013-16 program), this may prove an even thornier negotiating point than the tax, subsidy and spending parts of fiscal policy.

    Helpful change in US relations. The US has c16.5% voting rights at the IMF board. The shift from the overtly hostile rhetoric of Trump and Pompeo in H1 18 to a softer tone by the end of the year lowers the risk of a geopolitical block of an IMF deal. This change is a result of the US strategy to negotiate with the Afghan Taliban and establish a path to orderly troop withdrawal, both of which are made easier with Pakistan’s support.