Karachi 25, October, 2021: We anticipate interest rates to rise sharply in the coming months. We estimate at least a 50bps hike in the upcoming monetary policy and expect interest rates to touch 8.5% by the end of FY22. The external account imbalances and the consequent pressure on the Pak Rupee compelled the SBP to pull the trigger and kick-start the monetary tightening cycle. The move signaled SBP’s comfort over the sustainability of the economy’s growth trajectory amidst rising vaccination and falling infection rates.
As such, we believe the SBP will carry on its gradual pace of tightening with another 50-75bps hike in Nov21’s monetary policy. Moreover, we project interest rates to touch 8.5% by the end of FY22 (please read our detailed note titled: Pakistan Strategy: The impact of the 25bps hike).
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External account concerns take center-stage
After a comfortable FY21, both the Federal Government and the SBP have taken notice of Pakistan’s external account imbalances, which saw current account deficit (CAD) balloon up to USD 3.9bn in the past 3 months. Consequently, both institutions took policy measures to slow down external leakages.
The federal government plans to impose additional import duties on non-essential goods and has increased taxation on automobile purchases. The SBP, in turn, hiked the policy rate, reduced limits on consumer financing, and increased cash margin requirements for importing certain goods. These steps were introduced to slow down GDP growth rate and prevent economic overheating to unsustainable levels.
Global energy shortage pushing import bill
Despite steps to slow down imports, we are once again revising up our CAD estimates for FY22 because of record-high energy prices. Both LNG and coal prices have reached record-high levels, and are expected to exert considerable pressure on Pakistan’s import bill.
Coal prices have crossed their all-time high levels and are hovering around USD 190/MT because of global supply shortage and high demand (please read our detailed note titled: Analyzing high coal prices and their impact on Pakistan). We project coal prices to remain high over the medium term and expect incremental import value of the commodity to hover around USD 1.4bn in FY22.
Global LNG spot rates have also touched newer highs at USD 40/mmbtu (USD 224 BOE) because of surging demand during winter season. In view of rising reliance on RLNG, record-high spot rates have the potential to add USD 2.5-3.0bn on Pakistan’s import bill in FY21.
Inflationary concerns as IMF program re-entry imminent
Pakistan’s inflation is inching towards double-digits (+9.0% YoY in Sep21) because of high food prices amidst supply constraints. We expect a further uptick in monthly inflation as higher energy prices take their toll on the economy. Pakistan is all set to re-enter the IMF program and with it, we expect increased electricity tariffs and higher taxation to ensure economic targets are reached.
A hike in electricity tariffs likely: To recall, Pakistan withheld the road-mapped PKR 5.65/kWh increase in electricity tariffs to support economic recovery. We expect the government to follow through with the road map and hike the base tariff to ensure circular debt control, a key condition of the IMF program. Reportedly, Pakistan has agreed to a PKR 1.39/kWh hike in base electricity tariff. Moreover, higher energy prices are already pushing monthly fuel charge adjustments over PKR 2.5/kWh.
Higher PDL to increase fuel prices: To ensure fuel affordability, the government absorbing higher costs by reducing taxation. Presently, 10.2% of the fuel price is composed of government taxes vs. 43.6% back in Oct20. With a high tax (PKR 5.8tn) and PDL (PKR 610bn) target, we expect the government to further increase PDL once the IMF program commences.
Geo-political uncertainty hampering investor sentiments
Pakistan’s vocal support of the new Afghanistan regime amidst the political backlash towards the Biden Administration has further soured relations between Pakistan and the United States (US). The US is a key trade partner as Pakistan exported over USD 5.0bn (20% of total exports) worth of goods to the country in FY21. The US also has considerable influence over several international organizations including the IMF, The World Bank, and the FATF. Moreover, the US has the capacity to influence Pakistan’s other trade partners, particularly the European Union.
A recently moved bill in the US Senate aims to analyze the supporters of the Taliban regime during the past 20 years. If the bill passes and Pakistan is held responsible for abetting the regime, then the country faces the risk of potential economic sanctions. While we believe the likelihood of economic sanctions remains low because of Pakistan’s strategic importance in the region, investor nevertheless showed caution to the slim possibility.
