Macro Blog: Risks to the IMF program

Dear Friends,

The political chatter is becoming hard to ignore, though it is still missing from sell side commentary. I just returned from Islamabad and political intrigue was the main topic of discussion, both on coffee tables as well as on the 20-30 TV channels. Even the Prime Minister had to issue a clarification, denying the rumours that the Finance Minister and State Bank governor will be replaced (click here).

The Chairman of FBR formally resigned today (sighting health concerns). Tax collection this year is substantially below the IMF target. There is a news wire stating circulating on whatsapp that he says he has not resigned. The fact that all this drama is happening while the IMF team is in town for the 2nd tranche review shows the gravity of the situation. 

Things are not well. The political opposition parties are eyeing early elections and almost everyday there is some news that the Chief Minister of Punjab will lose his position (click here). Some say, that the Prime Minister is so close to the CM, that he might resign if the CM is pushed out. There are all kinds of gossip, which may or may not be true. Nevertheless, it is certain that it will be very difficult for a less strong political government to deal with a tough IMF stabilization program. 

Until the start of the month, my assessment was that the IMF might grant waiver to the government on the tax targets and Pakistan will get the second tranche. The main issue would come by June. However, from the press news flow, it seems that this could become a point of contention (click here). The government is rightly worried that the increase in utility prices and a further hike in the tax rate, will lead to further inflation. As Akbar Zaidi, the Dean of IBA very aptly put in his newspaper article, titled Destroying Livelihoods today (click here) all of the economic indicators which affect the common person have nose dived. 

Comparing the current economic policies of the government with its own political manifesto placed on the Prime Minister’s website (click here) makes for an ironic if not tragic read. 

While I do not think Pakistan will pull an Argentina but it is hard to ignore the risks to the IMF program. The political economy seems to be already near a break point. 

In the past, favourable relationships with the US has helped Pakistan get waivers on IMF conditions. However, those used to happen typically in the 3rd and the final year of the program. The fact that the government delayed entering the program meant that it wasted much needed political capital. Also I am not sure, if the US will still be as supportive this time as it has been in the past. CPEC could be the casualty. 

To make the situation further grim, Michael Kugelman from the Wilson Center believes that India and Pakistan are edging close to a war in 2020 (click here for his article in the Foreign Policy). We hosted Michael and Abraham Denmark, from the Wilson Center in Pakistan last week.

On the short term, the key risk is on the exchange rate. Given that most of the $3bn of portfolio inflows in the domestic currency bond market are in short duration papers (3 months), the State Bank will have a tough task to make sure that the exchange rate remains stable to prevent a disorderly outflow. I expect the exchange rate to slide to PkR/USD160 (from 155) by the end  of May 2020.

On the positive side, the decline in oil prices should help the government and might dampen some inflationary pressures. Turkey’s Erdogan is visiting Pakistan this week with a delegation of 57 businesses. This could also be a silver lining and Turkey might announce some investment deals. I suspect, there would be increasing support from Turkey, Qatar and Malaysia, the new geo-political block in Asia. 

I think the market will remain volatile and under pressure. There could be increased selling in stocks which have higher levels of foreign ownership. 

I am, yours truly,
Ali Farid Khwaja
Director
Khadim Ali Shah Bukhari Securities

* This is not research material and there is no investment recommendation in this blog. These are my personal views and do not represent the views of KASB Research team.