Market expectations high for Pakistan election

Matthew Turner
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A comprehensive set of structural reforms are needed to address macroeconomic imbalances, but market players appear quietly confident that Pakistan’s political risk premium will fall post-election, potentially restarting the stalled economic reform agenda.

Sell-side research houses are touting Pakistan’s general election on May 11 as a landmark event in the country’s torturous four-decade-long road to democracy, raising the prospect of the first civilian transition of power and the delivery of a coherent economic reform agenda. The Pakistan People’s Party (PPP), the country’s incumbent party, will struggle to retain power because of the government’s dire handling of the economy, predicts Credit Suisse. Instead, opinion polls favour Pakistan’s pro-business and centre-right party, the Pakistan Muslim League-Nawaz (PML-N), to win the election. The party’s apparent commitment to reforms in public sector enterprises (PSEs), energy, education and healthcare chime with Pakistan’s nascent middle-class and business community. Pakistan’s second-largest opposition party, the Pakistan Tehreek-e-Insaf (PTI), is led by former international cricketer Imran Khan, who suffered injuries at a party rally on Tuesday and was still recuperating in hospital a day later. The PTI’s election campaign is principally driven by identity politics, rather than economic ideology. “A strong PTI mandate would result in improved investment flows due to the likelihood of reforms,” states Credit Suisse. The PPP government, like its predecessor, was marred by corruption allegations, energy shortages and judiciary battles. While many see these instabilities as common features of the country’s political landscape, a research note by Eurasia Group suggests volatility has jumped in recent years. It states: “Many previously hailed ‘frontier’ markets, where political risk has destroyed the credibility of governments and created much more downside. Pakistan fits this description, with high-level political assassinations and an increasingly unstable government drawing less international aid and political interest.” Nevertheless, economic risk – principally Pakistan’s lack of fiscal firepower to make good on debt repayments to the IMF – constituted a substantial threat to its overall risk rating in 2012, as evidenced by the country’s poor performance in the ECR ratings last year. Under the current arrangement, Pakistan is due to make $7.5 billion in repayments to the IMF by November 2015. The country’s FX reserves have fallen in 2012 and now stand at just $9.8 billion, according to Moody’s. The government missed its original fiscal 2012 deficit target of 4%, returning 6.6% instead. “IMF debt servicing will swallow up a huge chunk of scarce reserves, but it is unlikely that a new IMF programme would trigger a default,” says Gabriel Sterne, senior economist at Exotix. A change of the guard at the presidential palace in Islamabad could also ignite long-overdue reforms in the energy sector. “The energy problems facing Pakistan today are perhaps the largest single impediment to higher economic growth and are a major factor behind macroeconomic imbalances,” according to the IMF. The PTI and PML-N have “offered a three-pronged approach to deal with the energy crisis, which [is] a major reason for anaemic growth,” notes Credit Suisse. These are “the import of cheaper fuels, such as gas instead of furnace oil; conversion of some existing power plants from furnace oil to coal; and improving administration within the energy sector where non-recoveries are approximately $1 billion a year”, according to the report. Game-changer?Poor governance has led to weak capital flows and falling central bank reserves, while real GDP growth slowed to just 3.7% in 2012. “[This is a] far cry from the 7%-plus rates that prevailed from 2004 to 2007 and less than half the rate required to absorb new entrants to the labour market,” states a report by Institutional Investor. An IMF press release on October 4 highlights the country’s challenging macro-economic environment in the lead up to the election. “Pakistan faces a challenging economic outlook,” it states. “GDP growth in 2012/13 is projected to be in the 3% to 3.5% range, which needs to accelerate in order to absorb the growing labour force. “Inflation has fallen recently but is expected to be back in double digits by the middle of next year if corrective measures are not taken to reverse monetary financing of the fiscal deficit. “Pakistan’s external position is weakening. While the current account deficit is not large by international standards, financial flows have weakened and central bank reserves have fallen.” Therefore, the ability of the new administration to mark an economic turnaround will hinge on the implementation of a comprehensive set of reforms, enforced by strong governance and sound policymaking – and a peaceful election outcome is a pre-requisite. Sterne at Exotix says: “We do not anticipate the May 11 elections will usher in a new dawn of improved governance in Pakistan, but the fact that a democratic-elected government lasted a full term is a positive, and the presidential elections later in the year will probably lead to a less divisive figure than the current president.”