Pakistan: Painful Path to Recovery

I am pleased to share with my readers a report by IMS Research. You may not agree with all the points, but it makes a good basis for an ‘Academic Discussion’. Pakistan needs a ‘home grown plan’ to overcome its inadequacies.

According to the brokerage house, FY23 Federal Budget saw the government attempt to widen the tax net, but the brunt eventually fell on the existing narrow tax base in the shape of higher corporate and personal taxes.

The benchmark index of Pakistan Stock Exchange (PSX) shed 3.6% (6.6% in US$), with turnover thinning out even further.

Foreign institutions and local insurance companies remained aggressive sellers. Pakistan is inching closer to the IMF program, but investor confidence remains low due to a sticky current account deficit, and ugly inflation prints around the corner.

That said, we believe risks are largely in the price, with default likely be avoided as the IMF agreement draws near. 

Inching closer to the IMF program

Pakistan has significantly reduced energy subsidies and sharply raised direct taxes. The 7th and 8th IMF reviews are reportedly being combined and Pakistan could see US$2 billion program resumption.

The FY23 Budget attempted to widen the tax net on real estate and retailers, but ultimately could not avoid further burdening the narrow tax base.

Most large corporates will now face additional 10% tax in in 2022, which reduces to a permanent +4% in subsequent years.

Improved fiscal discipline reduces the load on the monetary side but the State Bank of Pakistan (SBP) could yet raise rates on July 07, 2022 monetary policy, with the next inflation print expected north of 18% and international oil prices failing to come off. We expect an increase of 100bps, which will take the Policy Rate to 14.75%. This may be the last rate hike of the cycle though.    

Improving relations with others

Chinese commercial banks have recently disbursed loans of US$2.3 billion, negotiations are underway with Saudi Arabia to enhance the deferred oil payment facility, and UAE is reportedly interested in acquiring stakes in state-owned entities listed at the PSX.

Progress includes the appointment of a new US Ambassador to Pakistan for the first time since 2018, the visit of the German Foreign Minister, and a positive outcome in the recent FATF plenary with exit from the grey list looking likely subject to on-site verification.

A European Union mission also reached Pakistan to assess GSP+ compliance, and the broader improvement in relations with the West should help Pakistan’s case in our view.

The brokerage house assigns little probability to Pakistan procuring oil from Russia, even though local refineries have been asked to assess suitability, with political considerations likely to win out over economic ones.

Key risks

The government is digging in, going by its increasing willingness to take tough decisions and secure the IMF program. While coalition partners such as MQM have expressed discontent at the results of local body elections in Sindh, and PML-N rule is vulnerable in Punjab, it is difficult to envisage the coalition fracturing at this stage.

Imran Khan is a lot quieter but remains a uniting factor for the ruling parties, no matter their disparate nature.

For the economy, stabilization measures are underway and Moody’s decision to downgrade Pakistan’s outlook to Negative has not been matched by the other major credit rating agencies.

Corporate profits will hurt in the near-term, owing to the 10% super tax for 2022, but the impact on recurring profitability is modest. On market cap to GDP, Pakistan is cheaper than its Covid low and nearly as cheap as its trough during the global financial crisis.