Economics report 2019

A Report by Topline Securities Limited

Pakistan’s Ministry of Finance published the Annual Pakistan Economic Survey for FY18. As per the
Economic Survey, Pakistan’s GDP grew by 5.8% in fiscal year ending June 2018 (FY18), after 13
years, compared to 5.4% in FY17 and last 3-year average GDP growth of 4.7%. This is led by strong
growth in Agriculture and Services sectors. GDP grew slightly slower than targeted rate of 6.0% set
by Govt. primarily because of lower than the anticipated growth in industrial sector. Industrial sector
grew by 5.8% as against the target of 6.4%.

Agriculture sector (18.8% weight in GDP) posted growth of 3.8%, which is better than the last year’s
growth of 2.1% and higher than government target of 3.5%. Services sector (60.2% weight in GDP)
continued to post strong growth of 6.4% in line with target and last year’s growth rate. Growth in
services sector was mainly driven by improvement General Govt. Services (up 11.4% vs. 6.0% last
year) and Wholesale & Retail (up 7.5% in line with last year).

Industrial sector’s (20.9% weight in GDP) output stood at 5.8% lower than the targeted 6.4% and
higher than last year’s growth rate of 5.4%. Large scale manufacturing (LSM), the biggest
component of Industrial sector and comprising of 52% posted growth of 6.1%, slightly below
government target of 6.3%.

In terms of regional comparison (South Asian players), Pakistan fell behind regional players having
average growth rates of 6.1%, according to Economic Survey. Pakistan per capita income increased
by 0.4% to US$1,641 in FY18 (up by 11% in Rs. terms). We are of the view that ongoing economic
challenges in light of large external current account deficit will lead to further currency devaluation
and increase in interest rates. This is expected to slow down GDP growth to less than 5% during the
next few years as against the govt. target of 6.2% for FY19. We expect next year’s GDP growth to
be at 4.6% as rupee devaluation & expected hike in interest rates could slowdown economic growth.

We expect the fiscal deficit for the FY18 to at least remain at last year’s level of 5.8% and higher
than the budgeted deficit of 4.1%. As per the Economic Survey, fiscal deficit during 1HFY18 stood at
2.3% versus 2.5% in the similar period last year on account of improved revenues.

Total revenues for government in 1HFY18 was up 19.8% to Rs2.4tn. Tax revenues increased by
16% to Rs2.0trn, however, it remained well below the revenue target.

Non-tax revenues of the government increased markedly by 43% Rs358bn due to higher dividends,
markup payments, surplus profit of SBP, defense and PTA profits.

Total expenditures of the government rose by 14% to Rs3.2tn during 1HFY18 mainly driven by rise
in current expenditure (up 14% to Rs2.5tn). Federal Development Expenditures rose by 25% to
Rs616bn during the period.

For FY19, government is forecasting fiscal deficit of 4.9%, while we anticipate fiscal deficit to clock in
at 5%.
CPI inflation during 9MFY18 clocked in at 3.78% and it is anticipated to clock in at 4% for FY18
which is well below the inflation target of 6% set by Federal Govt. for FY18.

SBP has so far raised the policy rate by 25bps to 6.0% in 9MFY18 in order to curb mounting
pressures on external account.

We expect FY19 inflation to rise to 7% due to devaluation and expected increase in aggregate
demand. In light of anticipation of increase in inflation, we expect SBP’s policy rate to be raised by
175bps to 8.25% in FY19.

Investment to GDP ratio slightly improved to 16.4% in FY18 vs. 16.1% in FY17, lower than regional
peers. Private investment as % of GDP remained low at 9.8% vs. 10.0% during the previous year.
Further, Saving to GDP ratio of the country was reported at 12.1% of GDP in FY18 as compared to
12.0% last year. This is also on the lower side when compared to regional peers. Primary reason for
low savings rate is high consumption levels, which are prevalent in Pakistan.

Foreign exchange reserves of the country have been under pressure declining to US$10.9bn as of
April 20th, 2018 as against US$16.7bn in Apr 2017. Since Jun 2017, reserves have come down by
US$5.2bn (avg of US$0.5bn/month). This is due to rising current account deficit that increased from
US$8.0bn in 9MFY17 (2.6% of GDP) to US$12.0bn (3.8% of GDP) in 9MFY18.

Rise in current account deficit can be largely attributed to 21% increase in trade deficit to
US$22.3bn, driven by higher imports. Worker’s remittances slightly increased by 3.6% YoY,
somewhat supporting the current account deficit.

For FY19, government is targeting a current account deficit of US$12.5bn which is in line with our
estimate of US$12bn. This can only be achieved only if currency is further devalued and interest
rates are further increased.

Despite a large current account deficit number of US$12.0bn during 9MFY17, balance of payment
stood at a negative US$4.4bn only, thanks to inflows under the financial account in the form of loans.
This resulted in drag on the FX reserves during FY18.

Foreign direct investment, which is also a component of financial account, more or less remained flat
at US$2.0bn during Jul-Mar 2018. This is still considerably lower than the levels seen before 2008.

Outlook on external account remains bleak and we expect Pakistan to get into another IMF program
in 2H2018, which will be accompanied by currency devaluation and hike in interest rates that will
result in lower economic growth and shrinkage in external current account deficit.

Pakistan’s economy remains burdened with the challenges on external account where outlook on FX
reserves and CAD seems alarming. Despite this the govt. is targeting GDP growth of 6.2% in FY19,
which we believe is unlikely to be achieved. This is because Pakistan will have little option other than
to go to the IMF in 2H2018, which will be accompanied by strict measures including devaluation and
hike in interest rates along with expenditure controls that will adversely impact the country’s overall
economic growth.
Pakistan can avoid knocking IMF’s door, though probability of it happening is low, if the Govt.
manages to arrange decent external financing from friendly countries (like China & Saudi Arabia) by
3Q2018 along with taking corrective measures.

The recent Tax Reforms Package where the salaried class was given significant relief has set the
tone of expectations of further relief in upcoming budget. However, we believe that tax and other
populist measures could potentially be reversed or revised after general elections as the new Govt.
will want to set realistic targets amid external account concerns. This will include containing the fiscal
deficit below 5% as compared to at least 5.8% expected for FY18.

Pakistan has remained embroiled in political turmoil since the ousting of former Prime Minister,
Nawaz Sharif, by Supreme Court’s July 2017 ruling on corruption cases. Going forward, outcome of
National Accountability Bureau (NAB) hearings of Nawaz Sharif and upcoming General Elections
expected to be held towards the end of Jul 2018 will likely dictate market sentiments.