ISLAMABAD: There have been some positive developments on the economic front in Pakistan, but challenges including risks around current account, deterioration from fading remittances, and higher commodity prices and political pressure to stimulate growth would presumably require a reappraisal of the International Monetary Fund (IMF) programme targets, says JP Morgan – a global leader in financial services.
JP Morgan in its latest report, “Pakistan: Reassessing the investment thesis”, stated that given the forecast for a widening current account deficit, it expects USD/PKR to weaken to around 168.7 by June 2022.
The positive developments include the $6 billion IMF deal has resumed, the current account has been well supported, helping the rupee; preliminary estimates for fiscal year 2021 growth points to a sharp rebound from the Covid-19 shock; and the fiscal deficit should continue to shrink in GDP terms.
However, challenges remain.
These include risks around current account, deterioration from fading remittances and higher commodity prices; elevated risks of frequent Covid-19 waves given low levels of vaccination weighing on the growth outlook; largely negative real yields; and political pressure to stimulate growth, which would presumably require a reappraisal of the IMF programme targets.
“We assess the key issues and events investors should focus on in the coming months when evaluating the investment case for Pakistan include the IMF EFF deal, fiscal year 2022 budget, balance of payments dynamics, FX policy, monetary policy and growth outlook,” said JP Morgan.
If further stated that the favorable read-through from recent IMF developments has been credit positive amid strong investor interest towards Pakistan.
We add a new outright PKSTAN 8.25 percent 2024 long in line with our EM Asia sovereign theme of picking attractive yielding short duration bonds, while staying MW PKSTAN in the Model Portfolio given global considerations, it added.
JP Morgan stated that investors should be aware of some issues in the coming months including the extent of the government’s commitment to fiscal consolidation: The fiscal year 2022 budget due to be presented on 11 June is expected to pencil in further fiscal consolidation, although potentially less than initially agreed with the IMF, particularly as the government is now keen to stimulate growth; reduced remittances inflows likely will weigh on the current account, but increased financial flows should be supportive of the overall BOP; The current account has been well supported by remittances, but we expect this force to fade.
Higher commodity prices are also a drag on the external account; the SBP likely will continue accumulating FX reserves when it can: The combination of a wider C/A deficit and the Central Bank’s desire to increase reserves should result in a weaker rupee going forward; Monetary policy is set to become hawkish: the SBP continues to appear dovish in light of the difficult Covid-19 situation.
However, global financial conditions, domestic growth, inflation and CAB dynamics should tilt the balance toward some tightening; and the economy will likely grow around potential over the near- to medium term: We expect the economy to grow by around four percent in fiscal year 2022, but further Covid-19 waves and slow progress with the vaccine pose downside risks.
JP Morgan stated that the implementation of the current EFF to remain challenging.
After a lengthy renegotiation process, Pakistani authorities and the IMF reached an agreement to resume the EFF in March, which led to an initial $500 million disbursement.
A further $1.1bn should be disbursed later this month.
“The recalibrated IMF program has served as a boost to investor confidence as if implemented could prove transformational for Pakistan. However, challenges remain,” it added.
The IMF appears sympathetic of the government’s desire to make changes to the recalibrated agreement.
Additional hikes to power tariffs are seen as damaging amid double-digit inflation (10.9 percent on year in May).
In an effort to reduce the stock of arrears (5.0 percent of the GDP), tariffs were hiked by Rs1.95 per unit, pushing electricity CPI inflation up by 29.5 percent m/m in February.
However, authorities now are pushing to delay the previously agreed Rs1.4 per unit hike in tariffs scheduled for this June and Rs2.2 per unit in July 2021.
Furthermore, reports suggest that the Federal Board of Revenue (FBR)’s fiscal year 2022 tax collection target may be lowered to a more achievable Rs5.8trillion (10.8 percent of the GDP), from Rs6 trillion previously.
The FBR is on course to achieve the 2021 target of Rs 4.7trillion.
“We believe the IMF may be sympathetic to the government’s desire to recalibrate the fiscal targets as the Covid-19 situation has worsened since February when they were agreed,” it added.
“We now expect a fiscal year 21 fiscal deficit of 7.1 percent of GDP, close to the budget target of 7 percent. Pre-fiscal year 2022 budget discussions between the IMF and Pakistani authorities have been finalized, and we believe the fiscal deficit target for 2022 may be increased slightly to 5.9 percent of GDP, from 5.5 percent in the latest IMF review. Authorities have opposed introducing new major taxes, particularly for the salaried class; they would prefer to improve tax collection and broaden the tax base. Debt-to-GDP declined to an estimated 83.9 percent in fiscal year 2021, down from a revised 87.6 percent in 2020. We expect this to decrease again in 2022 (81.5 percent) if our pre-budget forecast is correct,” it added.
External financing to remain an important funding source for the budget.
In 2021, external financing was only meant to cover a quarter of deficit financing.
In the event, external financing covered a third of deficit financing in the first three quarters of fiscal year 2021, with this ratio expected to increase further.
Reliance on domestic financing to remain on the decline due to reduced interest from non-residents.
The Ministry of Finance will likely continue issuing less local currency debt as investor appetite has waned.
We expect the current account deficit to deteriorate in fiscal year 2022.
The significant rise in remittances and a smaller trade deficit due to lower imports resulted in Pakistan’s C/A swinging from a deficit of $6.1bn in 2Q18 to a surplus of $0.9 billion in 3Q20.
However, we expect a wider C/A deficit of $8 billion (2.4 percent of GDP) in 2022, from $2.3billion in 2021.
The current account deficit likely will widen at a slower pace.
After the recent revision of 2020 CAB to -1.7 percent of GDP (from -1.1 percent previously), we revised 2021 CAB to -0.8 percent of GDP (from -1.1 percent) and -2.4 percent in 2022 (from -2.7 percent).
While the deficit will likely be larger than it has been in recent years, it is still lower than between 2017 and 2019.
“We expect a 100bp policy rate hike later this year (from 7 percent to 8 percent, but risks of no-action remain high,” it added.
Copyright Business Recorder, 2021