Talks between Pakistan and the IMF ended last week without agreement, but the subsequent decision by the government to cut back fuel subsidies has cleared one of the major hurdles towards a deal being agreed. Financial markets in the country reacted well to the news, with equities and the currency climbing and CDS spreads falling back. As we have outlined before, an IMF deal is essential to putting the economy back on a more sustainable footing, but there is still a lot that could go wrong. Cutting subsidies will cause inflation, which hit 13.4% y/y in April (which is more than double the central bank’s target), to climb even higher. In addition to cutting back on spending, the IMF are likely to demand monetary policy is tightened further. All of this will weigh on living standards and could prompt renewed political unrest. The recently deposed prime minister, Imran Khan, has threatened to hold renewed protest rallies, while there is a mounting risk that some parties could start to pull out of the governing coalition, which may lead to early elections. The IMF will be wary of entering into an agreement if they think the government will not be around for long enough to complete the programme.
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