Pakistan Business Forecast Report Q4 2009

A Tortuous Road Ahead The Pakistani government doubtless has its work cut out over the remainder of 2009 and going into 2010, with the economy sagging and the battle against militants far from over. While there has been a surprising display of political unity as far as the need to push back the Taliban is concerned, this harmony masks lingering grievances which could easily resurface. Notably, while he has kept a low profile in recent months, the leader of the opposition Pakistan Muslim League-N, Nawaz Sharif, we do not believe that he has buried his ambitions of a political comeback. Judging by recent opinion polls his popularity is as strong as ever. On another front, friction between the government and the Supreme Court, now headed by the re-instated Chief Justice Iftikhar Chaudhry, over the raising of power tariffs and fuel taxes have underscored the conflicting pressures on the authorities - on the one hand to resolve the country's weak state finances, as demanded by the International Monetary Fund, and on the other not to inflict undue financial harm on the country's many poor.

The impending military offensive in South Waziristan will raise the risks of retaliatory attacks across the country, although the authorities are taking measures to prop up security in key urban areas.

Recent signs that different Taliban factions may be coalescing to take on the military suggest that the campaign could get messy and protracted, with the chances of a 'decisive' victory looking dim.

As for the chances of resurrecting peace talks with India there are a number of tough hurdles to be surmounted, including firmer proof that Islamabad is taking decisive action against the groups thought to have masterminded the Mumbai attacks in 2008.

While we have seen a partial improvement in many macroeconomic indicators, following a highly choppy 2008, new challenges are emerging which could prevent Pakistan from returning to the brisk growth rates seen in recent years. The economy is clearly losing pace, as reflected in recent GDP estimates for FY2008/09, and while there is monetary and fiscal stimulus in the pipeline, we expect growth to remain sluggish (at 2.5%) in FY2009/10. Notably, Pakistan's balance of payments have stabilised following rocky 2008, as reflected in a replenishing of the country's FX reserves and a more stable rupee. Lower international commodity prices and the confidence brought by the IMF's Stand-By Agreement has helped stabilise flows, but there are lingering questions surrounding the effects of the unstable security situation on foreign investment and the durability of the highly robust remittance inflows seen over FY2008/09.

The business environment remains highly challenging, with the shaky security situation and the dire energy shortage continuing to weigh on economic activity. Encouragingly, the energy-issue has not been neglected in the FY2009/10 budget, with a 100% y-o-y increase in the funds earmarked for the power sector to PKR22.8bn. There are plans to add some 2,921MW in generating capacity in collaboration with 15 Independent Private Power producers (IPP) over the next three years. Nine of theses projects (or 1,861MW) will be commissioned in 2009. While this should help alleviate the situation, it is less clear if it will be sufficient to keep up with demand, which has been growing at a pace of over 6% for the past decade.