IMF – EFF resumption around the corner
The Sixth review of the IMF’ Extended Funding Facility (EFF) is ongoing, and the recent news flow indicates that the government has agreed with the IMF on some fiscal measures including:
> Increasing power tariff to help contain the circular debt
> Ending of some of sales tax exemptions to keep the revenue collection target intact for FY22
> Giving full autonomy to the SBP
It appears that the finer details on structural adjustments are still being ironed out (Primarily new draft of SBP autonomy bill). IMF completed combined 2nd through 5th reviews in Feb-21 with disbursement of only USD 500mn due to govt’s failure to meet the quantitative and some of structural benchmarks.
The resumption of the IMF program would likely be paralleled by unwinding of the fiscal and monetary stimulus post COVID-19. Amid rising inflation, policy rate is likely to increase in order to achieve positive interest rates. The government will likely have to reverse part of its expansionary fiscal stance and aim for a more sustainable growth plan alongside increased focus on structural reforms, which have been on the backburner since the onset of COVID-19.
GDP growth rebounded in FY21, but there are question marks on future sustainability
FY21 GDP growth of 3.9% was broad based; driven by a combination of low base effect, and Govt stimulus led rise in local consumption. With falling investment during the last two decades, ICOR implied GDP growth potential has fallen by 70bps from 5.1% in 2000s to 4.4% in 2010s.
During the last two decades; surge in GDP growth beyond ICOR implied GDP growth potential have led to substantial weaknesses in external account; requiring painful adjustments and sharp decline in growth. GoP’s target of 4.8% GDP growth looks aggressive.
Current Account Deficit will likely rise to 3.5% of GDP or USD 11.2bn in FY22; a sub 100 REER is likely to persist
We expect CAD to rise to 3.5% of GDP in FY22 versus 0.6% in FY21, as imports growth is outpacing exports growth.
Imports are likely to grow 30% in FY22, exports are expected to increase by 20% and remittance by 9% YoY.
For the SBP to continue to build reserve buffer, the current BoP situation needs to be managed urgently. This would require a sub 100 REER. For FY22, we estimate PKR/USD to depreciate by 7%-13% and expect it to move in the range of 168.2-177.0 assuming a REER of 100-95.
CPI likely to surpass SBP’s targeted range (7-9%); Policy rate to rise until mildly positive interest rates are achieved
We expect FY22 CPI inflation to average 9.3%, surpassing SBP’s targeted range of 7-9% (GoP forecast of 8.2%). There are substantial upside risks from 1) Global commodity price surge, especially food. 2) Domestic demand revival, 3) Weakness in PKR.
We believe the era of accommodative monetary policy is behind us. We expect the central bank to undertake cumulative hikes of 225 bps, taking policy rate to 8.5% by May-22 and 9.5% by Nov-22. IMF may require a more aggressive rate hike.
Fiscal policy is expansionary; needs to be reigned in
GoP announced an expansionary FY22 budget with targeted net federal development spending up 36% YoY and subsidies up 59% YoY in FY22. ~44% of budgeted PSDP has already been released in 2MFY22. Continuation of this momentum will likely be inflationary.
There are risks to nontax revenue collection target; especially Petroleum Levy (PKR 610bn). 4MFY22 collection is likely to have been 4% of annual target. Nov-21 collection (net of subsidy) would likely be negative.