Emerging Markets
Bumpy ride to continue - Testing times ahead
A dip before a recovery:
Pakistan macros have weakened due to fiscal slippages, delay in reforms and countrywide floods. Looking ahead, we expect a bumpy ride in a low-growth, high-inflation environment. GDP growth is expected to dip to 1.6% in FY11 (Jul-Jun) with CPI inflation averaging 15.0% and policy rate peaking at 14.5-15.0% amid fiscal pressures. Recovery momentum thereof would hinge on fiscal reforms and energy supply. Meanwhile, sizeable deficit monetization from the central bank (SBP), higher commodities and delay in fiscal reforms remain the key risks.
FY11: A tale similar to last fiscal year
External financing remains critical to macro improvement via providing space to the private sector given a weak fiscal and financial account. In FY10, such financing fell short while fiscal deficit exceeded target, crowding out the private sector. In FY11E, the government intended to fund around 30% of its deficit (4.2% of GDP) through foreign flows but this again looks unlikely given a burgeoning fiscal deficit (6-6.5% GDP). Thus we expect limited private credit space; GDP growth should not cross 2.0% in FY11.
FY12E: Reforms a must for recovery…
“IMF led reforms” (fiscal and energy) – now a must – are likely to dictate capital flows in the medium term and for growth to revert to its historical mean of 5.0%. In 2HFY11E, while there should be some headway, we do not see these reforms shaping up materially, but gathering relative momentum in FY12E as IMF pressure builds up. In FY12E, we expect growth to recover to 4.3% and CPI to decline to 12% (due to base effect) but still some steps away from normalcy, ie, mean of 5.0% and 8.0%, with policy rate to head down to 12.5-13% in 2HFY12.
…and SBP to remain proactive, unlike 2008…
In 2011, we assign a low possibility of another BOP crisis akin to 2008, given (1) the SBP’s proactive monetary stance, unlike 2008 when it was reactive in tackling imbalances and PRs lost about 30% against US$, and (2) private sector surplus, unlike 2008 when it was also in a deficit along with fiscal. However, with debt repayment stepping up from 2012E, FX reserves could come under pressure if reforms take another back step, keeping the SBP cautious in easing rates.
…but watch nemesis and risks closely
Commodities (about 50% of import bill) have been Pakistan macro’s nemesis and we expect it to remain so. While our base case assumes higher commodity prices along with higher cotton export prices as a cushion, a super-spike like that of 2008, especially in oil, could prolong inflation moderation, hurt currency and delay the recovery process. In the meantime, failure to implement structural reforms and continued monetization of fiscal deficit from the SBP remain the key risks.
KASB Securities and Economics Research
24 January 2011
