Karachi, June 27, 2023 (PPI-OT): Will recent events make way for securing IMF deal?
In an emergent Policy meeting, State Bank's (SBP) Monetary Policy Committee (MPC) decided to increase interest rates by 100bp to 22%. The decision came after MPC decided to maintain rates at 21% in its scheduled meeting 2 weeks ago.
Where subdued domestic demand was reasoned for last status quo decision, MPC reasoned yesterday's increase by recent amendments to FY24 Budget bearing inflationary impact, hence targeting forward real interest rates in positive territory.
Secondly, MPC also highlighted recent withdrawal of strict import conditions as likely contributor to inflation as well, via expanding Current Account Deficit that may burden already scarce foreign exchange reserves, impacting PKR/US$ parity.
While the decision comes as a negative to macros, we believe the same, in addition to other recent events such as Finance Bill amendments, withdrawal of import restrictions etc., are key to unlocking IMF agreement to make way for external flows.
Policy Rate increased by 100bp to 22%
The State Bank of Pakistan’s Monetary Policy Committee (MPC) decided to increase interest rates by 100bp to 22% in yesterday’s emergent Policy meeting. The last meeting was held two weeks ago (12th June), in which the MPC maintained Policy Rate at 21%, reasoned by expectations of subdued domestic demand likely to continue, stress on external account and domestic uncertainty.
MPC reasoned yesterday’s Policy Rate increase a step towards keeping forward real interest rates positive as key events post last MPC meeting have now increased probability of higher than earlier expected inflation. These key events are (1) amendments to the Finance Bill and (2) removal of strict import restrictions.
Amendments to Finance Bill
After revealing the Federal Budget FY24 on 9th June, the government announced some amendments on the 23rd of the month which led to increase the already high revenue target of Rs12.16trn by Rs215bn (+2%), via measures including but not limited to increase in income tax on salaried persons, withdrawal of exemptions of various Sales Tax and increase/introduction of FED on various segments. These include tax and non-tax revenue measures. MPC views these measures bearing an inflationary impact.
In addition to that, the government also announced trimming expenditures by Rs85bn from the budget expenses announced (-0.6%). Higher taxes and lower expenses will result in lowering budgeted fiscal deficit by Rs300bn (-4%), taking FY24 Budgeted Fiscal Deficit as % of GDP from 6.5% to 6.3%. The amendments are more or less in line with reported gap between IMF and the government that now seem to have filled. We await updated budget documents reflecting the same.
Moreover, a key change to the Finance Bill has been made to section 99D, the much talked about tax imposed on unexpected profits, in which the government will now charge higher taxes on windfall income (determined through notification), limiting the same to companies and excluding individuals from the said section. The retrospective time period has also been reduced from five years to three years, which we believe will still be a reason for companies to approach courts.
Import restrictions withdrawn
To recall, SBP had imposed stricter import conditions since the past several months in order to manage the country’s depleting foreign exchange reserves. While the said administrative measures have somewhat led to the country’s current account balance to improve to the extent of reported surplus for the past three months, SBP has now allowed all imports. This measure is expected by the MPC to result in burdening SBP’s reserves, leading to pressure on PKR/US$ parity. As a result, higher prices in the domestic market may further burden inflation in the coming months. The withdrawal, however, also seems in line with reported recommendations from the Fund where import restrictions were reportedly not appreciated by IMF and were suggested to normalize.
Recent events make way towards securing IMF
SBP’s reserves stand at US$3.5bn, reflecting import cover of 4 weeks on restricted import levels and at 3 weeks at normalized import levels. For FY24, SBP reserves barely cover for the expected Current Account Deficit projected at US$4-5bn. This leaves the US$23bn debt obligations scheduled for FY24 in need of fresh external borrowings to fund the same, increasing importance of securing the ongoing IMF program, leading to disbursement by other lenders. We highlight, Federal Budget FY24 targets 3x YoY higher lending from global commercial banks (US$4.5bn), in addition to US$1.5bn worth of international bonds. Lending also include IMF’s tranches worth US$2.4bn.
As we had highlighted in our FY24 Budget report that IMF nods remains key to calm market nerves, the recent events led to the KSE100 Index increasing 3.4% in yesterday’s trading session. We expect momentum to continue barring unexpected turn of events, where we recommend Banking, E and P, and Fertilizer sector for higher D/Ys and decent capital upside, as recent results reaffirm our view. We highlight UBL, BAFL, MEBL, HMB, BAHL, MARI, POL and OGDC from the said sectors. We also prefer the Cement sector with MLCF, PIOC and KOHC among picks. Moreover, we also recommend Pharma sector amid talks on drug price increase, where we reiterate AGP among top picks.