PTI close to absolute Parliamentary majority (on preliminary data). The Pakistan election has resulted in PTI, the party led by the anti-corruption firebrand, Imran Khan, coming close to an absolute majority (an estimated 42% of seats, on local media estimates at the time of writing), which should mean that an alliance with Independent candidates establishes an absolute majority without an awkward outreach to Zardari’s PPP. Potential protests from all of the established parties (PMLN, PPP, MQM, JUI) that have lost out and, to varying degrees, rejected the results, will be short-lived because they bring these parties into direct opposition with the Army (a standoff they cannot win). We view this as a positive development for investors (we leave the debate on whether democracy has advanced to others). The PTI’s economic manifesto is largely focused on widening the tax net, reforming loss-making state-owned enterprises, reinvigorating exports and developing tourism. Recently, its public comments imply a reluctant acceptance that an IMF deal is needed urgently and existing Chinese project contracts will have to be respected.
Short-term, closer to IMF loan. The completion of the election clears the way for negotiation of the urgently needed IMF loan (the elected government can credibly commit to reforms unlike the interim government and although the PTI has historically emphasised self-reliance it has more recently indicated that there is little other option but to engage the IMF). This should re-establish the credibility of macroeconomic management after the loose monetary and fiscal stance and the overvalued, fixed FX rate in the latter stages of the previous elected government.
Long-term, a step to better economic governance. Pakistan’s fiscal policy is captured by vested interests from the undocumented (“black”) economy that do not pay tax or utility bills and gouge value out of state owned enterprises. As long as undocumented interests thrive then the only response to resulting fiscal deficits is to increase the tax rate on the documented part of the economy and increase government debt. A coalition of the Army (which has finally recognised that insecurity and corruption are interconnected and both must be addressed to preserve the very survival of the country, and with it, their own economic assets), an independent and interventionist Judiciary and the civilian government led by Imran Khan, may finally arrest this vicious fiscal cycle. Long-term, this is the potential change that overwhelms all other discussions around the election for investors. Otherwise, we are simply in for more of the same: buy Pakistan as it heads to the IMF and sell before the IMF loan ends.
The positive structural thesis and downside risks. The positive thesis is based on the following factors, the first four of which are already in place or on the way: (1) improving security; (2) stable geopolitical sponsorship; (3) an infrastructure upgrade; (4) orthodox economic policy; (5) an attack on the undocumented sector to establish fiscal sustainability (this is where the PTI victory is most impactful); and (6) growth in manufacturing exports. There are many risks to this positive thesis: (1) FX reserves are so low that there is a full-blown FX crisis before the IMF deal is concluded; (2) there is capital flight from domestic undocumented wealth fearful of an anti-corruption drive; (3) listed companies (although they sit squarely in the documented sector) are ensnared in this drive; (4) the side-lined traditional civilian political parties stoke insecurity (via protests or the activation of militant proxies); (5) the PTI is overwhelmed by its first attempt at federal administration; (6) the PTI encounter significant labour opposition to reform of state-owned enterprises; (7) the PTI attempt to renegotiate existing CPEC contracts; and (8) the Army backtracks, or selectively provides, its support for anti-corruption measures and better security.
Cheap equities and bonds. A lot of these downside risks are already priced into local currency equities (e.g. the KSE100 is on a 20% discount to 5-year average P/B, the largest bank, HBL, which is long US$ on its balance sheet, is on 1.2x P/B) and US$ sovereign bonds (e.g. the 2024s yield 8.0% with a z-spread of 510bps). The only factor preventing us from advocating an immediate, outright positive stance is that FX reserves are so low that any delay in the IMF deal could drive further material FX rate weakness.