With general elections scheduled for May 11, we believe the incumbent
Pakistan People's Party faces an uphill struggle for re-election. The
government's handling of the economy and its relationship with the
US are likely to be its key political liabilities. Unsurprisingly, based
on the consolidated results of two nationwide polls, the Pakistan
Muslim League-Nawaz is the current frontrunner.
Last year was one of Pakistan's deadliest and most violent on record,
which makes the Pakistani Taliban's recent peace overtures all the
Economic data coming out of Pakistan paint a relatively encouraging
picture with the economy looking poised to record a faster rate of
growth this fiscal year, in line with our expectations.
While key structural headwinds have receded, they have not been
resolved. Therefore, we are happy to keep our FY2012/13 real GDP
forecast of 4.0%, just below the government's 4.3% target.
Setting aside our constructive macroeconomic outlook on the country,
we believe that a potential balance of payments crunch could quickly
undo the economic progress Pakistan has made in recent years.
Our view for gradual weakness in the rupee continues to play out
well. Given the balance of payments dynamics in play, we expect
this gradual depreciatory trend to persist largely unabated.
The government unveiled its Strategic Trade Policy Framework for
2012-2015, which specifically prioritised the need to boost the country's
export earnings. On balance, while the framework contains both
positive and negative elements, we believe that it should improve
the country's external trade prospects over the medium term.
Despite the State Bank of Pakistan (SBP)'s dovishness over the past
two years, we do not expect the reverse repo rate to be taken below
the 9.50% mark, taking into account rising inflationary pressure on
the back of the ongoing surge in broad money supply growth.
The government's budgetary performance in the first half of FY2012/13
was neither encouraging nor alarming as the half-year budget deficit
was largely unchanged from recent years. That said, the lack of
any major fiscal reform suggests to us that another potential fiscal
blowout could be store in Pakistan as deterioration in second-half
budget discipline – a recurring phenomenon – coupled with rising
electoral pressures could prove to be a dangerous mix.
The fiscal incentives introduced by the recently finalised and longawaited
Special Economic Zones Act, 2012 should help to alleviate
the weak state of investment activity in Pakistan. The recent law is
a welcome move from the government.
Major Forecast Changes
We have nudged up our end-FY2012/13 and end-FY2013/14 consumer
price inflation forecasts upwards to 8.5% and 9.0%, from
8.0% and 8.5% respectively.
Key Risks To Outlook
Upside Risks To Inflation: Should external financing fail to
materialise or should the government fail to mobilise its domestic
resource base, it could result in further budgetary borrowings from
the banking system, thus stoking inflation. Externally, still elevated
global food and energy prices remain of particular concern from
an inflationary standpoint.
Downside Risk To Policy Rate: While we do not expect any additional
rate cuts from the central bank, we highlight that should the
SBP's latest measure fail to result in a substantial improvement of
economic activity over the coming months, then the likelihood of
further easing down the line would certainly increase. In addition,
given the looming general elections, political considerations will likely
continue to weigh heavily on the central bank's actions.
Downside Risks To Growth: As previously mentioned, several
structural factors continue to pose significant headwinds to growth.
Should any of these intensify in the coming months, real GDP
growth for the year could very well fall below our 4.0% projection.
Furthermore, we caution that a low-to-medium probability external
payments crunch could derail the Pakistani economy.