TREASURY GROUP May 10, 2011

Economic Insight
Macro Trends ahead of Budget FY12
So far, FY11 is proving to be a redemption year for Corporate sector with robust earnings growth. But, macro realities are contrasting. Interest rates are high, fiscal deficit is soaring and inflation is showing no signs of cooling down. The only blessing is a robust external account; but that too is overly dependant on remittances. Under these circumstances, we expect the government to announce a Budget focusing more on corrective measures, as limited resources and a tough outlook hardly allow a growthoriented budget.
Haider Hussain (92-21) 35361215-9, Ext.141 haider.hussain@pakbrunei.com.pk
Our Research is also available here.

Inflation
Inflationary pressures stand strong. Even if inflation stays at April-11 level (13.04%), moving average doesnt seem to be coming down before Sept-11

Trend in Inflation 16.0% YoY Headline Inflation 15.0% 14.0% 13.0% YoY Headline Inflation (12Month Moving Average)

12.0%
11.0% 10.0%

Jan-10

Jun-10

Jul-10

Dec-09

Aug-10

Sep-10

Nov-10

Dec-10

Feb-10

Mar-10

Feb-11

Jan-11

Apr-10

May-10

Source: Federal Bureau of Statistics, PBIC Research

Mar-11

Oct-10

Apr-11

Inflation
International food and oil prices are touching new highs and will also fuel domestic inflation going forward

Global Food Inflation (YoY Change)

80%

International Oil Price (Arab Light: USD/bbl)

130
120

60%

110 100

40%

90 80

20%

70 60

0%
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11

50 40 30

-20%

01-Jan-09

01-Nov-09

01-Jan-10

01-Sep-10

01-Sep-09

01-Nov-10

01-Jul-09

01-Jul-10

01-Mar-09

01-Mar-10

01-May-10

01-May-09

01-Jan-11

-40%
Source: Food and Agriculture Organization, PBIC Research

Source: Bloomberg

01-Mar-11

Inflation
Why not buy today what is going to be expensive in future! Increasing transaction demand for money shows general public have strong inflation expectations
Currency in Circulation (YoY Growth)
19% 17% 15% 13% 11% 9%
15-Jul-10 29-Jul-10
Currency in Circulation shows money hoarding and/or money held with public for daily transactions. It is the part of money supply that is outside the banking system

12-Aug-10

26-Aug-10

13-Jan-11

27-Jan-11

1-Jul-10

4-Nov-10

2-Dec-10

9-Sep-10

10-Feb-11

18-Nov-10

16-Dec-10

30-Dec-10

23-Sep-10

24-Feb-11

24-Mar-11

10-Mar-11

Source: SBP, PBIC Research

21-Oct-10

21-Apr-11

7-Oct-10

7-Apr-11

Monetary Policy Response

SBP sticks to a hawkish monetary policy stance. Trend in inflation increases the likelihood of a DR hike in the first half of next fiscal year

Inflation and Monetary Policy Response 14.5% SBP Discount Rate Headline Inflation (12-Month Moving Avg.) 14.0% 14.0% 15.0%

13.5%

13.0%

13.0%

12.0%

12.5%

11.0%

12.0%

10.0%

Jan-10

Jun-10

Nov-10

Aug-10

Dec-10

Sep-10

Feb-10

Mar-10

Feb-11

Jul-10

Jan-11

Apr-10

May-10

Source: SBP, Financial Market Association

Mar-11

Oct-10

Apr-11

Interest Rates
thus we are bullish on market interest rates in the medium term

Interest Rates Trend 15.0%

14.5% 14.0% 13.5% 13.0% 12.5% 12.0% 11.5% 11.0% 6-Month TBill 6-Month KIBOR SBP Discount Rate

1-Jun-09

1-Aug-09

1-Nov-09

1-Dec-09

1-Jun-10

1-Jan-10

1-Sep-10

1-Dec-10

1-Sep-09

1-Aug-10

1-Nov-10

1-Feb-11

1-Jul-10

1-Jul-09

1-Jan-11

1-Apr-10

1-May-10

Source: SBP, Financial Market Association

1-May-11

1-Feb-10

1-Mar-10

1-Mar-11

1-Oct-10

1-Oct-09

1-Apr-11

Interest Rates
Investors are preferring liquidity and are not ready to bet on long term securities. Risk premium is quite high between short and long (12-Month and above) tenors

Yield Curve as on May 4, 2011

14.5%

14.0%

13.5%

13.0%

12.5% 1m 3m 6m 12m 2Yr 3Yr 4Yr 5Yr 6Yr 7Yr 8Yr 9Yr 10Yr

Source: Financial Market Association

Fiscal Deficit
Deficit has been increasing big time. 9MFY11 deficit is 25% higher YoY

Quarterly Fiscal Defict (PKR Billion) 350 300 250 200

156

FY09
9-Month deficit PKR 406 billion Cumulative deficit PKR 680 billion (5.2% of GDP)

FY10
275
9-Month deficit PKR 627 billion 303 Cumulative deficit PKR 929 billion (6.3% of GDP)

9MFY11
9-Month deficit PKR 783 billion (4.5% of GDP) 293

276

224 180
138

223

214

150 100

112

50 0
1Q-09 2Q-09 3Q-09 4Q-09 1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11

Source: Ministry of Finance, PBIC Research

Fiscal Deficit Financing

Commercial banks have been financing a higher portion of deficit, which is one of the IMFs key requirements. Also because banks have limited alternate risk-free investment avenues

Government Budgetary Borrowing (YoY Growth)

32% 30% 28% 26% 24%

Breakup of GoP Budgetary Borrowing (YoY Growth)

70%
60% 50% 40% 30% 20% 10% 0%
1-Jul-10 15-Jul-10 29-Jul-10 12-Aug-10 26-Aug-10 9-Sep-10 23-Sep-10 7-Oct-10 21-Oct-10 4-Nov-10 18-Nov-10 2-Dec-10 16-Dec-10 30-Dec-10 13-Jan-11 27-Jan-11 10-Feb-11 24-Feb-11 10-Mar-11 24-Mar-11 7-Apr-11 21-Apr-11

From SBP
From Scheduled Banks

22%
20% 18% 16% 14% 12%

-10%
10-Mar-11 31-Mar-11

4-Nov-10

12-Aug-10

23-Sep-10

25-Nov-10

Source: SBP, PBIC Research

Source: SBP, PBIC Research

16-Dec-10

17-Feb-11

27-Jan-11

21-Apr-11

1-Jul-10

22-Jul-10

2-Sep-10

14-Oct-10

6-Jan-11

Fiscal Deficit Financing

And this shift in borrowing has compelled the government to offer higher returns on Treasury Bills

TBill Auctions: 6-Month T-Bill Weighted Average Yield

14.0% 13.5% 13.0% 12.5% 12.0% 11.5% 11.0%

27-Jan-10

16-Jun-10

28-Jul-10

15-Jul-09

04-Nov-09

30-Dec-09

23-Sep-10

26-Aug-10

15-Dec-10

09-Sep-09

02-Dec-09

15-Nov-10

24-Feb-10

24-Mar-10

09-Feb-11

12-Jan-11

21-Apr-10

19-May-10

Source: SBP

10

09-Mar-11

07-Oct-09

20-Oct-10

06-Apr-11

External Account
A robust current account is mostly depending on remittances, which is a hard-to-predict quasi-exogenous factor

Current Account Deficit (12-month mov. avg.) USD Billion

25 Ex. Remittances Actual

20

15

10

0
Jul-08 Jul-09
Jul-10

Jan-09

May-08

May-09

Jan-10

Jan-08

May-10

Jan-11

Nov-08

Nov-09

Source: SBP, PBIC Research

11

Nov-10

Sep-08

Sep-09

Sep-10

Mar-10

Mar-08

Mar-09

Mar-11

Exchange Rate
Exchange rate has stabilized around PKR 85/USD following a rejuvenated external account, while foreign exchange reserves position is also strong

Reserves Position and Exchange Rate

20 18 16 14 FX Reseves, PKR Billion (LHS) PKR/USD (RHS) 87 86 85 84 83 82 81 80 79 78

12
10 8 6 4

2
0

Aug-09

Jun-10

Jun-09

Aug-10

Jul-09

Jul-10

Feb-10

Jan-10

May-10

Jan-11

Nov-09

Dec-09

Sep-10

Dec-10

Sep-09

Nov-10

Feb-11

Source: SBP, PBIC Research

12

Mar-10

Mar-11

Apr-10

Oct-10

Oct-09

IMF Repayments
However, both reserves and exchange rate would face headwinds after Dec-11 when repayments to IMF will start escalating

Repayments to the IMF (USD Million) including principle & interest payements and other service charges
CY11 USD 362 Million CY12 USD 2,467 Million CY13 USD 3,976 Million
1,046 918 784 647 521 514 680 649 560 375 218 128 103 131 61 1 217 909 1,103

CY14 USD 2,264 Million

CY15 USD 497 Million

3Q-CY11

4Q-CY11

1Q-CY12

1Q-CY13

2Q-CY13

3Q-CY13

2Q-CY14

3Q-CY14

4Q-CY14

1Q-CY15

Source: IMF, PBIC Research

13

4Q-CY15

1Q-CY11

2Q-CY11

2Q-CY12

3Q-CY12

4Q-CY12

4Q-CY13

1Q-CY14

2Q-CY15

3Q-CY15

Federal Budget FY12

What would be on the cards?

We expect Budget FY12 to be a replica of Budget FY09 when economy was experiencing a
fiscal crisis, despite the fact that macro indicators are in a relatively better position now

Similar to FY09, upcoming Budget will also focus more on stabilizing the economy through
corrective measures. Despite the commitment of economic managers, limited resources and a tough outlook hardly allow a growth-oriented budget

Budget FY12 will primarily focus on fulfilling IMF requirements

RGST reforms and a modest focus on Agriculture income tax is on the cards, though they are likely
to face political resistance

Possibility of the imposition of one-off Gross Asset Tax on corporate sector assets Likelihood of upward revision in the rates of existing direct taxes GoP cant afford to announce a large PSDP in current circumstances, especially when a fat chunk
of resources will be transferred to provinces through NFC award

Subsidies will be restrained further We cannot dream of significant pro-poor measures in this budget. But, some additional resources
for Benazir Income Support Program (BISP) can be set aside
14

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