Karachi, November 22, 2021 (PPI-OT): Pakistan resumes the IMF program after major policy shifts including the recent 150bps rate hike

State Bank of Pakistan (SBP) has increased policy rate by 150bps, faster than anticipated, as the balance of risks shift from growth to inflation and the current account swells faster from rising import demand and international commodity prices. Simultaneously, the IMF staff level agreement has concluded after the recent fiscal and institutional policy adjustments and Pakistan is likely to obtain US$1.06bn after the Fund’s board approval. We highlight that these policy shifts are not massively contractionary in nature as strong economic recovery has gained hold with expectations of FY22E GDP growth of 4.8% (IMF: 4%) still intact. There is still enough room for investors to cherry pick equities which may likely be shielded and/or gain from the pace of monetary tightening.

SBP increases policy rate by 150bps

As heightened risks to inflation and balance of payments have started to loom largely due to rise in import demand and international commodity prices, the balance of risks has moved from growth towards inflation which continues to bear the impact of Rupee depreciation. In addition to this, taking leads from the regional central banks, the narrative of inflation being transitory is shifting towards a longer outlook on inflation. Simultaneously, the impact of rising Current Account Deficit (CAD) to US$5.08bn (4.7% of GDP) was only being borne by the exchange rate, hence, there was an inherent need to increase policy rate by 150bps to be able to share the burden of rising CAD.

This does not actually impact the end goal of mildly positive Real Interest Rate (RIR). Nevertheless, after this move, the RIR still stands in a mildly negative territory. What is more in the offing is that Monetary Policy Committee (MPC) has changed the calendar for policy announcement to 8 meetings per annum from 6 previously. This will likely enable the central to overcome any preponements or emergency announcements to be able to address any grave and noticeable uncertainty in the future. What is more pertinent to note that the next MPC meeting is in the next 25 days of the recent announcement i.e. Dec14’21 which puts Pakistan is a suitable position to be able to make more adjustments till the expected IMF Board meeting after staff-level agreement was reached yesterday (Nov21’21).

IMF program resumption holds a lot of positives

Even though the policy shifts required by authorities towards resumption of IMF program were unpopular in nature, this effectively brings Pakistan towards more economic stability as the Fund has cited that “economic outlook continues to face elevated domestic and external risks, while structural economic challenges persist”. The Fund has stressed that the monetary policy needs to keep focused on curbing inflation and the independence of SBP has to be strengthened through SBP Act Amendments. This will allow SBP to adopt an inflation targeting (IT) regime in the medium-term; enabling of IT regime requires more efforts than the recent policy rate hike of 150bps and Cash Reserve Requirement (CRR) hike to 6% (previously 5%).

More actions towards fiscal consolidation need to follow despite the recent run of 47%QoQ and 45%YoY growth in FBR tax collection to Rs1.40tn. Due to declining trend of non-tax collection from low Petroleum Development Levy (PDL) collection (Rs13bn, down 90%YoY) against higher expenditure, primary balance surplus has halved to 0.3% of GDP from last year. Hence, the government will likely move towards introduction of fiscal measures to reduce the primary deficit via receding the Rs170bn tax concessions, introduction of Finance Bill with Rs400bn new tax measures, enhancing PDL collection, spending restraints towards PSDP by Rs200bn, among others.

Energy sector reforms are also important for financial and economic viability and they will require a steadfast implementation of Circular Debt Management Plan (CDMP) where energy tariff hikes will be implemented while only subsidizing the vulnerable end-consumers.

Multi/bilateral flows can bridge external funding requirement

Heavy growth in import demand owing to rising machinery and automobile imports in conjunction with high international commodity prices has overwhelmingly shielded positives from the increase in exports. CAD of 4MFY22 now stands at US$5.08bn, higher than the entire FY20 CAD of US$4.45bn and more than twice the FY21 CAD of US$1.92bn. Resultantly, our reserve asset accumulation continues to get eaten away by these external pressures. The current momentum of economic recovery has gained hold from COVID19 stimuli while more growth is expected as we tread beyond FY22, a year onward, as more and more TERF related investments will likely be enhancing economic output. Additionally, the resumption of the Fund program will unfold significant amount of bilateral and multilateral flows to be able to overcome the funding gap.

Secondary yields have continued to shift upwards

We had highlighted earlier that mounting inflationary expectations were already being incorporated in secondary market yields also underpinned by the weakening of Rs/US$ parity and the 6M -T-bill was already trading at 173bps higher than the then policy rate. The 6M KIBOR has already crossed the double-digit mark to reach 10.03% which signals re-pricing of assets quicker than anticipated.

With a hefty portion of rate hike already priced in, the secondary yields have continued to mount, making banks more attractive. We highlight that mid-tier banks like BAFL, BAHL and FABL will bear more positives than the larger names such as HBL, UBL and MCB, owing to a higher rate sensitivity and comfortable CA mix.

Regaining market confidence

While E and Ps require more structural changes in terms of circular debt management to be able to overcome from cash getting strapped into receivables, their excess cash position make a good case of additional other income. On the other hand, Banks will likely be able to realize NII growth while entering CY22 and continue to bear fruits of monetary tightening.

We believe that a mild re-rating of the KSE100 PE multiple of 5.5x will likely be witnessed in 2022 while further re-rating towards 10year average PE of 8.2x will remain contingent to improvement in external imbalances and government’s continuous push towards implementation of structural changes ranging from SBP’s autonomy and circular debt management to refinery upgradation.