The new government is debating whether or not to eliminate
power and gasoline subsidies. However, with a projected fiscal deficit of PKR
4.2 trillion (6.6 percent of GDP) and a current account deficit (CAD) of USD 17
billion, these subsidies are unsustainable (5.3 percent of GDP).
PM has begun gathering friendly country support as well as
reviving the IMF plan to shore up reserves. Despite the difficulty, success on
this front is vital to maintaining financial stability. The outcomes of the
government's attempts to shore up foreign reserves are encouraging. Government
Bonds, Treasury Bills, and Equities, which have recently been under pressure,
should be given breathing room through financial support from friendly
countries, the IMF, and multilaterals.
In this section, we go through the political and
macroeconomic outlook in Pakistan’s economic imbalances and the future forward,
and what it means for capital markets in the short and medium term.
Politics may be on the down, but it is far from lifeless
Though the PDM was successful in deposing the PTI
government, ruling through a coalition of 14 parties, ranging from the extreme
left (Mohsin Dawar's NDM) to the far right (Moulana Fazul ur Rahman's JUI),
would not be easy. The entire political atmosphere is heating up as a result of
PTI's popular demonstrations in major cities, which might worsen if the
protests turn into a protracted march. However, we anticipate that any unrest
would be brief, and that the coalition government will continue to hold the key
to calling early elections.
Macroeconomic concerns necessitate an IMF program, but will the government take the unpleasant pill?
A silver lining arises as the new administration engages
with the IMF, with IMF officials planning to visit in the coming month to
negotiate the program's continuation. The incoming finance minister, Mr. Miftah
Ismail, also wanted to boost the program's size from USD 6 billion to USD 8
billion. It will, however, need certain unpleasant steps, such as the
elimination of power and fuel price subsidies. To remind you, the government is
paying a monthly subsidy of PKR 64 billion to maintain pump prices at current
levels, compared to PKR 104 billion set aside for four months. Petrol and
diesel prices must be hiked above Rs. 170 and 195, respectively, in order to
meet revenue projections.
Inflation may rise as
energy costs rise
Recent inflation estimates of over 12.7 percent are already
close to a 24-month high, bringing the average for July-March 2022 to 10.74
percent, up from 8.3 percent a year ago. This was related to the commodities
super cycle, which arose following a fast demand rebound during Covid, with supply
being unable to keep up due to logistical difficulties. All main commodity
prices have surpassed their all-time highs. The invasion of Ukraine by Russia
fueled the flames even more because both nations are key players in the grain
and oil markets.
The loss of electricity and fuel subsidies, on top of the
high inflation base, will push inflation even higher in FY22, bringing the
average to 12%, while a continued high level of main commodities might push
inflation to approach 15% next year. Please keep in mind that energy costs make
up just 10.2 percent of the inflation basket, so the direct impact of the fuel
price rise on total inflation is roughly 2.6 percent, but the second-round
impact on commodities prices would raise the overall inflation base.
To reduce the current account deficit, some demands must be reduced
As previously mentioned, higher commodity prices contributed
to the widening of the Current Account Deficit (CAD), which reached USD 13.2
billion in 9MFY22 compared to USD 275 million the previous year. Though a 7.1
percent increase in worker remittances helps, the widening trade imbalance
(55.5 percent year over year) negates the remittances' benefit.
The government will have to swallow the painful pill of
boosting fuel prices in order to curb consumption and keep the current account
deficit from worsening. For FY22, we forecast CAD of USD 17.6 billion (5.3
percent of GDP), the highest level since FY18, when the country posted CAD of
USD 19.2 billion (6.1 percent of GDP).
Outlook for the Capital Markets
As previously stated, twin deficits are the key. Despite the
fact that the market is presently trading at relatively favorable levels, its
full potential will only be realized if pressure on the twin deficits is
relieved by inflows from friendly nations and the IMF. Strong values, a good
earnings growth projection, and a low likelihood of aggressive foreign selling
all indicate to significant potential in the medium run. Please also keep in
mind that the market now offers an 8% dividend return, indicating that there is
minimal downside from here.
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