While short-term default risks have subsided, medium-term risks persist unless authorities take proactive steps toward debt sustainability
Last week’s IMF deal is a sigh of relief for firms operating in Pakistan. By averting a short-term default, concerns of immediate and extreme shortages of necessities, acute inflation, widespread civil unrest, and an extreme weakening of the currency have been avoided. Furthermore, the lifting of import restrictions will facilitate the procurement of crucial raw materials for domestic production.
However, firms should note that the stringent conditions accepted by the government will introduce its own set of challenges. Corporate plans made based on the June 9 budget announcement will need to be revisited and adjusted based on the details of the revised annual budget. Firms should also expect a substantial escalation in the cost of production and credit in tandem with changes in taxes, higher electricity tariffs, and a further increase in interest rates. B2C companies should also prepare for an augmented cost burden on end consumers due to these adjustments.
Overview
The past 10 days have been extremely eventful for Pakistan’s economy. After the IMF rejected the FY 2023–2024 budget for non-compliance with its conditions, authorities scrambled to get the remaining US$ 2.5 billion bailout back on track. The government passed a new budget in parliament that included higher taxes and energy prices and reduced spending by US$ 295 million; the central bank raised the benchmark interest rate by an additional 100 basis points in an emergency meeting and removed restrictions on imports. With only a few hours remaining before the deadline, the IMF announced a stand-by agreement with Pakistan to disburse US$ 3 billion (more funding than expected), pending approval from the IMF Board.
Our View
This deal is important because it helps the country avert a debt default in the immediate term. Short-term bond, equities, and currency markets reacted with optimism to this news, with rallies in all three markets. The deal also opens the door to additional funding from China, Saudi Arabia, and Qatar. However, firms should avoid conflating this short-term optimism with the expectations of a smooth operating environment in the coming year. The IMF stand-by agreement was reached after confronting exceptionally challenging policy decisions that will inevitably lead to elevated costs of electricity, credit, and a broad range of consumer goods.
Aside from short-term cost concerns, the country has about US$ 21 billion in external debt due by the end of 2023. With low foreign reserves, high interest rates, and a very volatile currency, the IMF amount may amount to nothing more than a short-term stopgap measure, potentially raising default concerns again in a few months if the government does not focus on long-term debt sustainability measures.
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