Elixir Securities Limited – Elixir Insight

Karachi, September 25, 2018 (PPI-OT): Pakistan Economy – CAD Expected to Fall to USD13.4bn in FY19

We expect FY19F CAD to fall to USD13.4bn (4.6% of GDP) from USD18.1bn (5.8% of GDP) in FY18 as we expect slowdown in ex-petroleum imports, particularly for that in Machinery.

The sharp improvement in CAD for Aug-18 (USD600mn) is unlikely to normalize at these levels as we believe this has been a result of SBP delaying import payments due to its limitations attributable to critically low FX reserves level (PBS data shows trade deficit to be on the higher sude) – it nonetheless augments the overall direction that we are eyeing for FY19

We expect Gross External Financing Requirement to stand at USD22.7bn (CAD: USD13.4bn / External Debt Servicing: USD9.3bn) in FY19F compared with USD25.6bn (CAD: USD18.1bn / External Debt Servicing: USD7.5bn) in FY18.

Though government is making all out efforts to arrange foreign financing in the form of loans and investments, we believe that Pakistan will still be opting for fresh IMF program due to critical FX reserves level and record high CAD.

CAD Expected to Stand at USD13.4bn (4.6% of GDP) in FY19: According to State Bank of Pakistan’s (SBP) recently released data on external account, Current Account Deficit (CAD) grew by 10%YoY to USD2.7bn (5.3% of GDP) in 2MFY19 from USD2.5bn (4.6% of GDP) in 2MFY18 led by 8%YoY growth in imports to USD11.6bn in 2MFY19. The latter was mainly driven by higher petroleum imports owing to rallying international oil prices.

On monthly basis, CAD showed remarkable improvement declining by 72%MoM to USD0.6bn (2.3% of GDP) in Aug-18 owing to 19%MoM decline in import payments to USD5.2bn in Aug-18 from USD6.4bn in Jul-18. While these numbers show significant improvement, CAD is unlikely to normalize at these levels as we believe this has been a result of SBP delaying import payments due to its limitations attributable to critically low FX reserves level. This is also confirmed by 3%MoM growth in goods imports (as reported by Customs/PBS data) to USD5.0bn in Aug-18 from USD4.8bn in Jul-18.

Considering momentous improvement in current month to be temporary, we estimate FY19F CAD to decline rather moderately by 26%YoY to USD13.4bn (4.6% of GDP) from USD18.1bn (5.8% of GDP) as we foresee imports to decline by 1%YoY to USD66.0bn. Our estimate is premised upon projected 7%YoY decline in ex-petroleum imports owing to ~18%YoY PKR/USD depreciation, monetary tightening and stringent regulatory duties.

Financial Account Balance Increase Led by SAFE Deposits: Financial Account Balance grew by 110%YoY to USD2.7bn (5.3% of GDP) in 2MFY19 from USD1.3bn (2.4% of GDP) in 2MFY18 mainly due to US2.0bn in contracted other liabilities corresponding to State Administration of Foreign Exchange (SAFE) deposits from China. On the other hand, Foreign Direct Investment (FDI) declined by 40%YoY to USD0.3bn in 2MFY19 from USD0.5bn in 2MFY18. Moreover, net outflow in Foreign Private Investment (FPI) continued unabated, standing at USD0.1bn in 2MFY19.

Knocking on Every Lender’s Door: With growing CAD and resultant increase in external borrowings, we estimate Gross External Financing Requirement to stand at USD22.7bn (CAD: USD13.4bn / External Debt Servicing: USD9.3bn) in FY19. While Pakistan is still in talks with Saudi Arabia and China for financing arrangements in the form of both loans and investments, we believe that it will still have to knock on IMF’s door (and any other lender) as financing requirements remain at unprecedented high levels which tanked SBP’s FX reserves by 51% to USD9.3bn (import cover: 1.5 months) from a high of USD18.9bn (import cover: 4.5 months) in Oct-16 due to external imbalances and inadequate financing arrangements.

We believe following measures will be taken to address Twin Deficits and likely be required by the multilateral lenders (i.e. IMF among others): 1) PKR depreciation, 2) increase in import duties on luxury/non-essential imports, 3) monetary tightening, and 4) increase in taxes and reduction in subsidies. The said measures will likely take a toll on slowing down GDP growth to under 5.0% in FY19F. Besides, we expect PKR to depreciate by 8% to 135 by Jun-19 based on REER of 108 in Jul-18.

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