Karachi, July 03, 2023 (PPI-OT): IMF’s gift - An unexpected Eid Mubarak!

In a surprising but welcome development, Pakistan and the IMF reached staff level agreement for a US$3bn (SDR2,250mn) Stand-By Arrangement (SBA). The agreement is likely to be approved by the Board in mid-July and will be valid for a period of 9 months.

The SBA replaces the 2019 Extended Fund Facility (EFF) program which was slated to expire by June end with the 9th and 10th reviews pending. Within the SBA, the IMF has stressed implementation of Budget’24 as planned avoiding the pitfalls of unbudgeted spending, ensuring a market determined exchange rate as well as strengthening the viability of energy sector.

Pakistan being in an IMF program, albeit an SBA instead of EFF, will help unlock much needed material US$ inflows from both multilaterals and bi-laterals. On the latter, in the immediate term, expect inflows of US$2-3bn from Saudi Arabia and US$1bn from UAE to materialize while support from China to continue. On the currency, we expect a slight pullback with normalcy to resume if trade is opened while on the market, expect a broad based rally albeit for a short period, given undemanding valuations, with KSE-100 P/E at less than 3x. For a sustained bull run at the PSX, economic reforms have to be the order of the day where failure on that part will just have kicked the can 9 months down the road.

Pakistan enters an IMF SBA: In a surprising but welcome development, Pakistan entered an IMF SBA for a period of 9 months. The SBA replaced the outgoing EFF program, which the country failed to complete with 9th and 10th reviews left pending. Overall, the SBA has been signed for US$3bn (SDR2,250mn), slightly above the US$2.6bn due in the remainder EFF program. This is the 13th SBA Pakistan has entered into in its history while the 3rd since the year 2000.

Within its statement, the IMF has acknowledged external shocks Pakistan’s economy has faced in the recent past, while also highlighting some Government’s missteps including functioning of the Fx market. That said, moving ahead, the IMF has lauded GoP’s actions that it hopes will be implemented including i) Budget’24 where a primary surplus of 0.4% is expected, ii) SBP’s withdrawal of guidance for import prioritization will result in a fully market determined exchange rate and iii) efforts to improve the viability of the Energy sector, improve SOE governance and strengthening the public investment management framework.

Despite the SBA being larger than the now defunct EFF program (pending payments), remember that the SBA is a short gap arrangement and has only bought Pakistan time to carry out reforms before Pakistan will need to enter yet another IMF program. As such, it is paramount that expenditures are kept controlled (despite it being an election year) while reforms on the tax collection front, energy front etc. are carried out lest we are left standing at the same spot 9 months later as we were in June’23.

Currency - improvement may be short lived: Administrative steps or import prioritization has resulted in Pakistan managing its Current Account side, with 11MFY23 CAD at just US$2.9bn. More importantly, since Jan’23-to date, Pakistan has posted a CA surplus of US$817mn mainly backed by import restrictions. That said, the SBP through its circular on June’23 has withdrawn all restrictions on imports to facilitate the industrial sector.

With market participants pricing in the worst, an unexpected entry into the IMF program will likely result in a knee jerk improvement in the USD/PkR parity, however, we opine the improvement may be short lived particularly if imports open up as slated through the SBP notice. Import numbers moving ahead will be interesting with pent up demand likely to come to the fore if restrictions are indeed removed.

Elections on the anvil? With Pakistan finally under an IMF program and Pakistan’s PM being personally accredited for getting the deal done, the country may potentially now be moving towards elections. General elections and end of uncertainty in this regard will be a welcome development for the investment community. The tenure of current National Assembly is set to expire by August 12’23 where we expect the PM to terminate the NA earlier than its expiry date given provision of 90-day caretaker set-up / electoral campaign in case of earlier termination. Next parliament is largely expected to be a hung one where what type of coalitions are set up will be an interesting story.

Market - Make hay while the sun shines: Given the unexpectedness of the IMF program (most market participants were holding their breath on likely expiration), the adage ‘sell on news’ is not really applicable here. In the near term, we expect a broad based rally, with blue chips likely leading the charge, given undemanding valuations with market P/E below 3x. Historically, market’s performance post the SBA has been mixed with positive returns of 15.4%/10.1%/4.1% in 1M/3M/6M post an SBA in Nov’00 while negative returns of 27.5%/35.0%/22.2% post the SBA in Nov’08 with the negative returns explained by Pakistan’s precarious external situation back then.

That said, as stated earlier, the SBA has only kicked the can nine months down the road where for a sustained rally, reforms on the economic front (particular focus on Taxation, Energy and SOE side) need to be carried out. For now, make hay while the sun shines.