Clarity emerging but speed bumps ahead for Pakistan's economy

So its finally over. Imran Khan became the first PM in Pakistan’s history to be ousted by a no confidence vote (NCV). Millions will cheer and millions will weep. There will be much debate in the wake of his departure about what went wrong and how it could have been different. I will leave that analysis to the “experts” but remind everyone that nothing is permanent in Pakistani politics and far greater comebacks have been witnessed.

The Pakistan Tehreek-e-Insaf (PTI) would serve us well by playing an effective role in opposition, ensuring we do not return to a two-party system and keeping the youth engaged in a more civil parliamentary democracy.

Coming back to my supposed area of “expertise” i.e. the economy and capital markets, what can we expect?

The PSX will respond positively to the emerging political clarity and perception that the new government has historically been pro-business. Interestingly, over the last several sessions, individuals became net buyers in the equity markets (USD 16.9 million this month). There is speculation that this buying is being done by in the know HNWs who foresee a sustained rally post the NCV. Valuations are at multi-year lows while earnings remain resilient and dividend yields attractive.

There are expectations of a foreign policy course correction that will allow our exit from the FATF grey list and an inflow of USD from international creditors. Therefore the currency may also get some much needed respite. Last week the PKR hit an all time low of 188 and a recovery from here would not be surprising.

The incoming government has its work cut out on multiple fronts and bullish perceptions of its business prowess will soon meet the harsh truth of ground realities. We can expect the new opposition to exert maximum pressure in and out of the assembly

We may also see fixed income markets rally in response to the improving outlook for external funding. In particular, treasury bills which had breached the 13% mark may see a decline, so that the spread over the policy rate normalises.

The question of course is how sustainable will this initial bounce be?

The economy faces several challenges which have to be addressed on a priority basis.

Inflation is expected to cross the 15% mark this summer as stubbornly high commodity prices, a weak currency and subsidy reversals will hit consumer prices hard. The incoming government will have limited options (as a price taker) other than administrative measures to limit the damage. Higher interest rates in an unbanked cash economy can only go so far.

We have bled USD 5 billion from our FX reserves over the last one month and our monthly financing needs are around the USD 1-billion mark. The new government will need to have a game plan to stem this flow and rebuild quickly. Options are limited as Eurobond borrowing is prohibitively high while IMF funding requires tough decisions like increasing petrol, electricity and gas prices.

Fiscal measures will have to be taken including privatising loss making SOEs, expanding the revenue base and cutting expenditures as the deficit is projected to hit an all time high of PKR 4.3 trillion this year. Proposals have recently been floated to increase the tax rates for salaried individuals. These will be deeply unpopular as middle income group earners have seen a major hit to their purchasing power over the last 5 years.

Ensuring the steady supply of energy including coal, furnace oil and LNG will be crucial. Prices for these inputs have skyrocketed amidst supply chain disruptions that have seen multiple defaults from sellers. Recent gains on the export front could quickly be lost if a solution is not found.

The incoming government has its work cut out on multiple fronts and bullish perceptions of its business prowess will soon meet the harsh truth of ground realities. We can expect the new opposition to exert maximum pressure in and out of the assembly. Thus it remains to be seen whether the administration can take the necessary but potentially vote denting measures to stabilise the economy.

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