After experiencing significant depreciation in FY23, the local currency has regained ground over the last four quarters, supported by the IMF Stand-by agreement, contained current account deficit and reduced political instability. Notably, the sharp devaluation during FY23 caused significant hardship for the common people due to the economy’s structural weaknesses, primarily in the form of higher inflation. Since most daily use items, including food and energy are linked to the PKR/USD exchange rate.
Analysts at Insight Securities believe that in the coming months, Pakistan is likely to report current account surplus due to subdued domestic demand and favorable commodity prices. Imports are averaging ~US$4.5bn on TTM basis and we opine that given the slowdown in domestic demand, imports are expected to remain subdued resulting in contained CAD in next few quarters. Additionally, remittances, which had been lackluster during CY23 due to domestic uncertainty and the gap between official and unofficial exchange rates, have started to recover, approaching CY22 levels. After recording peak of US$3.1bn in Apr’22, remittance could not sustain the momentum amid political and economic turmoil and fell to US$1.9bn by Jan’23. However, since Mar’24, remittances have rebounded strongly, averaging US$3.0bn/month and reaching a high of US$3.2bn in May’24. We believe this momentum is likely to continue, as our thesis is based on the significant shifts in the economic and political landscape over the past 12 months, with uncertainty having somewhat subsided. Additionally, concerns over a sharp devaluation are no longer prevalent. Therefore, we estimate workers remittance to depict YoY growth of ~15% in FY25, to clock in at ~US$35bn.
These developments are promising as Pakistan faces significant foreign debt obligations and FX reserves that are insufficient to cover 3 months of imports. This presents an opportunity for the central bank to strengthen reserves, and we may see some appreciation of the local currency as a result. Empirically, we analyzed quarterly data since FY03 and identified 17 instances where the average CAD was below US$100mn. In 11 of these instances, the domestic currency appreciated against the USD. That said, several factors could influence the currency movement, such as global interest rates and timely approval from IMF’s board. To highlight, the latest REER reading stands at ~102, depicting that currency is close to equilibrium in context to base year. Further, the USD is likely to depreciate in the coming months due to expectations of a rate cut. This also bodes well for us, as it will help keep our REER at a suitable level. Another factor to consider is the primary income, which recorded a deficit of US$8.6bn in FY24, up by ~50% YoY, amid pending dividend & profit repatriation. According to authorities, the backlog of pending payments has been cleared, and no such backlog currently exists. Going ahead, payment of outstanding amount pertaining to Chinese IPPs can put pressure on balance of primary income. In the event of a healthy current account surpluses, we expect the central bank to beef up its reserves, which would not only aid in negotiations with lenders, particularly the IMF, but also provide a cushion for stakeholders to implement structural reforms.
From equity market perspective, investors will closely monitor the quantum of CAS, as it could act as a catalyst for market performance and aid the process of securing a new IMF program, which is currently awaiting board approval due to delay in commitments on external financing from friendly countries. If domestic currency appreciates, sectors like textiles and IT, which have dollar-denominated revenue streams, may come under pressure, while the pharmaceutical sector and other import-dependent industries could attract investor interest.