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Reza Baqir’s Presser: Economy on a Mend

The Governor of State Bank of Pakistan (SBP), Mr. Reza Baqir, recently spoke on Pakistan’s economy at an international forum. Following are key takeaways:

 

As per the Governor, the primary cause of Pakistan’s economic malaise was its burgeoning current account deficit (CAD) that used to be less than USD500mn in early 2016 and increased to USD1.5-2.0bn per month by mid-2017. The exchange rate was fixed during this time and was not allowed to adjust to bring the CAD down to reasonable levels.

 

The increase in CAD came from a consumption driven boom where consumption expenditure was noted close to 6% of GDP in FY18 compared to an average of 3-4% in this decade.

 

The other point of economic concern was the steep increase in fiscal deficit that rose to a high of 9% in FY19 compared to low of 4.5% recorded in FY16.

 

Going to actions by the current government, the first and foremost was the adjustment in exchange rate that has been undertaken in the last 18 months, where the currency is now trading at USD/PKR parity of 156 compared to 106 in Dec’17, a devaluation of around 30%. This has led to a reduction in CAD, which was last reported at a multi-year low of USD260mn for Sep’19 (compared to USD1.2bn in Sep’18). The Governor highlighted the rise in volumes in exports that are up by more than 10% during the last 18-mths due to a more competitive exchange rate environment.

 

The Governor delved on the tax drive by the current government and highlighted the improved fiscal picture as shown below. He stated that surplus on primary fiscal balance is a notable achievement.

 

The Governor elaborated that due to currency devaluation and adjustment in utility prices to reduce the fiscal deficit, inflation has risen in Pakistan during last 18-mths from low single digits to double digits. Consequently, SBP has raised the Policy Rate by 7.5% to 13.25% during the last 18-mths to address the rising inflation.

 

The Governor highlighted the rise in Portfolio investments in Jul-Sep’19 that has been driven by foreign inflows in debt securities. Total portfolio flows were net positive at USD346mn during Jul-Sep’19 compared to outflows in previous quarters. The bulk of these (USD333mn) came in debt securities while the remaining balance was in equities. The Governor highlighted that the government was working on reducing tax incidence on foreign investment in local debt markets.

 

 

The Governor further moved to discuss the outlook for Pakistan’s economy. The Governor highlighted that Pakistan’s recourse to the International Monetary Fund (IMF) programs have always been due to depleting foreign exchange reserves. This time around, he opined that Pakistan has made structural changes to address depleting foreign exchange reserves and strengthen the foundations of the economy.

 

First and foremost among these reforms is the market determined exchange rate where the exchange rate is ascertained by market forces and the central bank steps only to address any disorderly condition in the foreign exchange market. Secondly, there is now zero borrowing from the SBP, which will ensure that government spending does not overstretch and overall debt levels are kept in control. Lastly, there are renewed fiscal reforms given the ongoing tax drive and concerted efforts to raise savings and investments in the country.

 

We believe that the Governor’s assertions are in line with our view that Pakistan’s economy has begun to stabilize. Reduction in both external current account deficit and fiscal deficit point towards a stable exchange rate and subsequent monetary easing given reduced pressure on inflation going forward. We are of the view  that given inflation has now peaked; there may be room for cut in interest rates going forward. We expect 50 basis point cut in Policy Rate in upcoming monetary policy review in Nov’19 and expect a further 75 basis points in 2020 and forecast the Policy Rate to reduce to 12% by Dec’20 from current 13.25%.