Boston, MA -- (SBWIRE) -- 11/22/2013 -- The leaders of India and Pakistan met face-to-face on the sidelines of the UN General Assembly in September, demonstrating that relations between the two nuclear-armed powers remain cordial despite rising tensions in recent weeks.

Against the backdrop of the high degree of political legitimacy conferred by the turnout in the 2013 general elections, the Pakistan Muslim League-Nawaz (PML-N)'s strong showing suggests to us a more stable government setup over the coming years, and one that will have more legislative freedom to enact its agenda. The strong and ongoing support for the PML-N as seen in the August by-elections illustrates the public's continued patience with regards to the party's more conservative economic agenda.

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2012 was one of Pakistan's deadliest and most violent years on record, which makes the government and the Pakistani Taliban's peace overtures all the more significant.

Real GDP growth is forecast to slow further to 3.4% this fiscal year (FY2013/14 [July-June]) as the economy undergoes a painful - but necessary - adjustment on the back of a general tightening in both fiscal and monetary policy.

The economy is likely to continue to be plagued by the difficulties posed by the long-running energy crisis and the still-poor security environment.

Against our expectations, the rupee has weakened quite considerably over the past few months, largely due to the IMF's condition on the necessity for the country to accumulate reserves. Setting aside this weakness, we continue to believe that the country's balance of payments outlook is sound.

The State Bank of Pakistan decided to hike its benchmark policy rate by 50 basis points to 9.50% in September, largely in line with our view. We see consumer price inflation averaging 9.0% this fiscal year and expect another 50 basis points worth of further tightening.

The PML-N's budget for FY2013/14 largely stuck to the party's 2013 manifesto. While it is implementation that matters most, we cannot help but be encouraged by the administration's ambitious agenda to reverse the deterioration in Pakistan's fiscal position. We are pencilling in a reduction of the government's deficit to 6.8% of GDP in FY2013/14.

Major Forecast Changes

We have downgraded our FY2013/14 real GDP growth forecast to 3.4% from 4.0% previously.

We have increased our FY2013/14 reverse repo rate forecast to 10.00% from 9.00% previously.

Key Risks To Outlook

Upside Risks To Inflation: Should external financing fail to materialise or should the government fail to mobilise its domestic resource base, it could result in further budgetary borrowings from the banking system, thus stoking inflation.

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