The financial world loves a good turnaround story. It’s had its fair share in recent years of course. Just look at UBS or the big US carmakers — or even once-untouchable peripheral eurozone nations like Greece.
But rarely has any institution or sovereign enjoyed the sort of remarkable recovery enjoyed over the past 12 months by the Islamic Republic of Pakistan.
A landmark $6.7bn bail-out loan agreed between the South Asian state and the International Monetary Fund in September 2013 has put its finances back on the right path and the country is on the move again.
Having dipped as low as $2.8bn in February 2014, Pakistan’s foreign reserves are again on the rise, hitting $9.6bn in July. That same month, analysts at Moody’s revised upward the outlook on the sovereign’s rating to ‘stable’ from ‘negative’, citing “stabilising external liquidity”. Economic growth is projected by the IMF to tick up to 4.3% in the year to end-June 2015, from 4.1% in fiscal 2014.
Analysts have been quick to applaud progress made under the third Nawaz Sharif administration. “Economically I’m very positive about Pakistan’s prospects,” says Farrukh Sabzwari, director of regional equities sales at Credit Suisse in Singapore. “The feelgood sentiment is back.” In a June 12 research note, Capital Economics applauded the “progress that has been made in shoring up the economy’s external position”.
That point is certainly true. Pakistan has spent the past year tapping capital from myriad sources, including the World Bank, the Asian Development Bank and the Kingdom of Saudi Arabia. In April 2014, the country printed $2bn worth of notes in its first international bond sale since 2007, comprising a $1bn five year tranche and a $1bn 10 year. In August, the government said it was drawing up plans to issue its debut sukuk — a bond that complies with Islamic law — by the end of 2014, in response to strong investor demand for frontier-market sovereign debt.
An improving economic climate and fiscal picture has in turn boosted the outlook for Pakistan’s embattled banks. In June, Moody’s raised the outlook on the ratings of five domestic lenders — Allied Bank, Habib Bank, MCB, United Bank (UBL) and National Bank of Pakistan (NBP) — to ‘stable’ from ‘negative’. On August 18, in a research report titled Positives all round, Credit Suisse noted that “improving macros and a business-friendly government” had created a “sense of optimism” among local corporates, with capital expenditure set to rise sharply in sectors including energy, textiles and communications. “Banks are well placed to support the likely uptick in credit demand,” said the report, which tipped loan growth to expand by a compound annual rate of 16% over the three years to end-June 2017.
This, though, is where the tricky part starts. Pakistan has reasserted its business-friendly credentials yet so far it has “only tackled the low-hanging fruit”, notes Credit Suisse’s Sabzwari. “Now comes the far harder challenge.” This phase of restructuring one of Asia’s most ramshackle economies will not be simple or particularly pleasant. Assuming the process is even partially successful, it will take years and even decades, likely involving a reasonable amount of civil unrest.
Broadly speaking, the reforms fall into three categories: addressing energy shortages, privatising public sector firms and giving tax authorities powers to collect unpaid bills from the wealthy and powerful.
Energy is perhaps the biggest structural challenge. Pakistan has suffered from a chronic power crisis for years, compelling people to go without electricity for up to 16 hours a day. Companies with financial wherewithal buy expensive, fuel-dependent generators to keep turbines revolving and cotton looms spinning. Yet this factor, above all others, is also the single biggest deterrent for foreign investors. It’s a “big turn-off”, noted Capital Economics in a June report. “Firms in Pakistan suffer bigger losses from electricity shortages than in any other major economy in Asia.”
Little wonder the IMF has tied specific tranches of its current bail-out loan package to the successful implementation of a series of key energy reforms. These include raising electricity prices, imposing measures to clear arrears in the power sector and forming a workable strategy to shift the country’s energy mix towards clean coal and renewables and away from gas and heavy oil. During talks between the IMF and the Pakistan government in Dubai in late August, the Fund linked delivery of its latest quarterly loan tranche of $550m to a concrete commitment to boost power tariffs by 4%.
Nor will the laborious process of privatisating state assets be easier. Most of Pakistan’s economy remains, in one form or another, in the throttling grip of the state — whether directly, via government institutions, or through the myriad holdings and cross-holdings of the country’s sprawling, all-powerful military. Long term economic reform can only happen when the military agrees to winnow down its direct stake in the economy, but this won’t be easy. The military’s two largest commercial interests, the Fauji Foundation and the Army Welfare Trust, are also Pakistan’s largest business groups.
Sharif and IMF pull Pakistan back from the brink When Nawaz Sharif was elected premier of Pakistan in June 2013, the country’s economy was in a perilous state. Foreign exchange reserves had slipped to dangerously low levels over the previous 18 months and would continue to fall for months to come. Inflation was running at close to 10% while growth was on track to hit 3.7% in the 12 months to end-June 2013, down from 4.4% the previous year. This was hardly virgin territory for the south Asian economy, victim of endless coups and military interventions and propped up for years by generous Chinese loans and US aid packages. Sharif, though, was determined to break Pakistan’s damagingly endless cycle of debt and deficit. A natural businessman, he set out to patch up relations with the one institution that could help Pakistan in its hour of need: the International Monetary Fund. Fund executives in Washington were wary at first. Pakistan dodged a balance of payments crisis in 2008 after securing an $11bn loan from the IMF — only to see it suspended in 2012 after repeatedly missing economic and reform targets. The country needed help: that much was clear. But would yet another round of talks, possibly culminating in yet another bail-out loan, achieve anything? Moreover, was Pakistan really capable of pushing through key reforms, notably privatising state assets, slashing subsidies and boosting tax revenues? Such measures would put the economy on a more even keel. But they would also alienate and anger the wealthy businessmen and army officials who earned the most and had the most to lose from any break from the status quo. Both sides, however, overcame any initial doubt. Pakistan, simply put, needed the capital. Sharif was both a new broom and an old hand, having run the country from the premier’s office on two previous occasions, and he knew the IMF well. Moreover, the Fund wanted to re-engage with Pakistan without giving the impression of appearing too keen. Pakistan’s external stock had risen as a result of a peaceful transition from one democratically elected government to another that involved no military intervention. Détente in the end was quick and decisive. By the first week of September 2013, Sharif had secured signatures on a 36 month, $6.7bn programme designed, the Fund’s regional adviser Jeffrey Franks said, to “bring the fiscal deficit to a more sustainable level”. By end-August 2014, four tranches of the facilities had been disbursed, totalling $2.8bn. |
So it’s heartening to see the Sharif administration push ahead with plans to whittle down the state’s share of economic output. In August 2014, the government released a list of 32 public sector entities it was keen to privatise, from energy majors such as Pakistan State Oil Company to the likes of State Life Insurance, Pakistan Reinsurance and National Power Construction Corporation. “The list of potential divestments is impressive,” notes Sayem Ali, senior economist, Middle East, Pakistan and North Africa at Standard Chartered Bank. “The government has shown its determination to push ahead with important divestments; now, it’s a case of ensuring that the privatisation process gains, and retains, traction.”
Other big names on the privatisation bucket list include potential national champions, including the country’s largest steel producer, Pakistan Steel Mills, and Pakistan International Airlines (PIA). The latter in particular has big potential. Long one of the world’s most chronically underperforming carriers, it boasts plum routes to the great cities of Asia, Europe and the Middle East. “If they get PIA right, it could become a great and really important airline,” says one Karachi-based businessman. “It has so much potential but it needs to be better run. Only private capital can change that.”
The state will also seek to sell partial stakes in a quartet of lenders, including UBL, NBP and Habib Bank. “Even the fact that the government has admitted that it doesn’t need to hold on to stakes in these companies is a step in the right direction,” notes Credit Suisse’s Sabzwari.
SECURITY FEARS
Security remains an issue for Sharif, who faces threats from terrorists as well as his own military. In June, Taliban forces briefly captured Karachi airport, killing 38 people. And in late August, thousands of protestors tried to storm the premier’s house in the capital, Islamabad, prompting fears that the military would be compelled to intervene. (Others accused parts of the army of fomenting the unrest, in reaction to Sharif’s attempts to strengthen civilian rule, and to boost relations with Afghanistan and India.)
Pakistan has come far over the past year. Sharif’s third stint as the country’s premier has already cleared the lower hurdles: proving the country is open to business and complying with 10 of the 21 structural benchmark reforms drawn up as part of the IMF’s September 2013 bail-out loan package.
The remaining 11 benchmarks involve the higher hanging fruit: harder to reach and pick. These include slashing the fiscal deficit, addressing energy shortages, boosting the tax take and pushing ahead fully with a wholesale divestment of public sector enterprises, challenges that are “likely to face widespread political opposition”, Moody’s said in an August 20 research note.
Capital Economics summed up the situation Sharif still faces in its June report: “A nightmarish bureaucracy, a lack of government effectiveness and rampant corruption are all likely to continue holding back Pakistan’s economy.”