Pakistan Country Risk Report Q1 2020

Pakistan Country Risk Report Q1 2020

We at Fitch Solutions believe that the Belt and Road Initiative's China-Pakistan Economic Corridor (CPEC) will improve Pakistan's growth prospects over the long term, driven by an expected increase in exports as trade relations and export competitiveness improves. Moreover, various infrastructure projects will likely help to deepen physical and human capital in the country. That said, we see financing as a potential challenge to future CPEC projects in the short run, as private investors will continue to be deterred by Pakistan's poor business environment.

We expect Pakistan's balance of payments to strengthen over the coming months, as the USD6bn bailout package from the International Monetary Fund (IMF) will help Pakistan to rebalance its economy. Foreign direct investment as part of the China-Pakistan Economic Corridor projects and loan packages from other international partners will also provide some support to Pakistan's reserves. We believe that the sustainability of the external balance over the longer term hinges on Pakistan's ability to deliver a material improvement in its fiscal balance.

We are revising our forecast for the State Bank of Pakistan (SBP) to maintain its policy rate at 13.25% for the remainder of FY2019-20 (July-June), versus our forecast for a 50bps hike previously. With a new base year (FY2015-16) for the Consumer Price Index (CPI), Pakistan is likely to record a smaller inflation figure going forward versus if inflation was computed with the previous base year (FY2007-08). We have revised our forecast for inflation to average 11.5% in FY2019-20, from 13.0% previously, as subdued oil prices and slowing economic growth will help to reduce inflationary pressures.

We believe that clashes between India and Pakistan could intensify over the coming months due to India's revocation of Kashmir's special status, although the conflict is likely to be contained within Kashmir. While not our core view, we see rising risks of military conflict between India and Pakistan, given the likelihood of an extended Indian military presence in Kashmir, and Pakistan's interest in challenging India's control of the region. China, an interested third party, is unlikely to materially intervene in the conflict as long as the Line of Actual Control separating it and India is respected. In light of ongoing elevated tensions between the two nations, we are revising our short-term political risk scores for India and Pakistan to 67.6 and 47.1, respectively out of 100, from 71.0 and 47.5 previously.

Key Risks

Pakistan would need to achieve a material improvement in its fiscal outlook to ensure long-term sustainability of its current account and reserves. Owing to the country's large fiscal deficit (estimated by the Ministry of Finance to come in at 7.2% for FY2018/19), Pakistan has been trapped in the vicious cycle of borrowing to finance its debt and government spending. This has contributed to the high interest rate of 13.25%, depreciatory pressures on the currency and a widening current account deficit. Failure to sustainably narrow its fiscal deficit could also lead to inflation as the government leans on the SBP for additional borrowing, as had happened in 2008, 2013 and 2019 ahead of the IMF bailout packages. Should inflationary pressures persist, there could be the risk that Pakistan tries to return to a fixed-exchange rate regime in an effort to contain inflation, which would renew downward pressure on reserves.

Risks to our forecasts are for the SBP to continue hiking its benchmark policy rate. Inflation could come in above our forecasts if the government continues to borrow excessively to fund its fiscal spending, or if oil prices start to rise in the case of a sustained disruption to oil supply. This could prompt further rate hikes from the central bank to curb inflation.

Risks to our currency forecast are weighted towards rupee weakness. If Pakistan fails to achieve the targets laid out by the IMF, the disbursement of the IMF loan could be delayed. This would likely have a negative impact on investor sentiment and spur capital flight from the country. Pakistan's emerging market status also makes its domestic assets particularly vulnerable to a sell-off in episodes of market risk-off sentiment. Specifically in the region, elevated tensions between Pakistan and India over the disputed Kashmir region also puts the Pakistani rupee at risk of a significant sell-off in the event of a further escalation in violence in the Kashmir valley.


Executive Summary
Core Views
Key Risks
Country Risk Summary
Economic Risk Index
Political Risk Index
SWOT
Economic – SWOT Analysis
Political – SWOT Analysis
Economic Outlook
Economic Growth Outlook
CPEC A Boost To Pakistan's Long-Term Growth, But Short-Term Challenges Remain
TABLE: PROPOSED SEZS UNDER CPEC
GDP By Expenditure Outlook
TABLE: GDP GROWTH FORECASTS
TABLE: PRIVATE CONSUMPTION FORECASTS
TABLE: GOVERNMENT CONSUMPTION FORECASTS
TABLE: FIXED INVESTMENT FORECASTS
TABLE: NET EXPORTS FORECASTS
External Trade And Investment Outlook
IMF Bailout To Help Support Pakistan's Balance Of Payments
Outlook On External Position
TABLE: NET EXPORT AND IMPORT PARTNERS
TABLE: MAIN IMPORTS AND EXPORTS
TABLE: CAPITAL & FINANCIAL ACCOUNT BALANCE
TABLE: CURRENT ACCOUNT BALANCE FORECASTS
Monetary Policy
Pakistan To Hold Monetary Policy As Inflation Stabilises
Monetary Policy Framework
TABLE: MONETARY POLICY FORECASTS
Structural Fiscal Position
TABLE: MAIN REVENUE AND EXPENDITURE CATEGORIES
TABLE: FISCAL AND PUBLIC DEBT FORECASTS
THIS COMMENTARY IS PUBLISHED BY FITCH SOLUTIONS MACRO RESEARCH and is NOT a comment on Fitch Ratings’ Credit Rating. Any comments or data included in the report are solely derived from Fitch Solutions Macro Research and independent sources. Fitch Ratings’ analysts do not share data or information with Fitch Solutions Macro Research.Pakistan Country Risk Q1 2020ContentsCurrency Forecast
Lower Oil Prices A Relief For Pakistani Rupee
TABLE: CURRENCY FORECAST
10-Year Forecast
Pakistan 10-Year Forecasts
Significant Opportunities For Growth
TABLE: LONG-TERM MACROECONOMIC FORECASTS
Political Outlook
Domestic Politics
India-Pakistan Skirmishes Over Kashmir To Intensify, But All-Out War Unlikely
TABLE: POLITICAL OVERVIEW
Long-Term Political Outlook
Instability To Prevail, But Outright Collapse Unlikely
TABLE: SCENARIO MATRIX: EVOLUTION OF STATE
TABLE: SCENARIO MATRIX: CENTRIFUGAL VERSUS CENTRIPETAL FORCES
Operational Risk
TABLE: OPERATIONAL RISK
Economic Openness
TABLE: TARIFF AND NON-TARIFF TRADE BARRIERS
TABLE: FREE TRADE AGREEMENTS
TABLE: FREE TRADE ZONES AND INVESTMENT INCENTIVES
TABLE: BARRIERS TO FDI
Utilities Network
TABLE: ELECTRICITY RISKS
TABLE: FUEL RISKS
TABLE: TELECOMMUNICATIONS RISKS
TABLE: WATER RISKS
Global Macro Outlook
Downside Revisions To Stabilise Somewhat, But Policy Risks Remain
TABLE: GLOBAL MACROECONOMIC FORECASTS (2018-2023)
TABLE: DEVELOPED MARKETS – REAL GDP GROWTH, % y-o-y
TABLE: EMERGING MARKETS – REAL GDP GROWTH, % y-o-y
Index Tables
TABLE: PAKISTAN – MACROECONOMIC DATA & FORECASTS

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