Pakistan had requested for a waiver for its inability to meet quarterly budget deficit target and net government borrowing limits from the State Bank of Pakistan.

Murilo Portugal, IMF’s deputy managing director and acting chairman said, “preparations for important and politically difficult tax reforms have moved forward, and there has been steady progress in financial sector reform”.

IMF has approved total of $10.66 billion loan for Pakistan and with the release of $1.13 billion it has disbursed $7.27 billion so far. IMF has also accepted Pakistan’s request to merge the remaining three payment instalments into two. The IMF said Pakistan has missed two conditions because of the delay in getting pledged aid from other nations.

Portugal said, “Pakistan’s vulnerabilities remain high, due to persistent inflation, security-related spending pressures, energy-sector problems and shortfalls in revenue collection and external financing”.

United States is exerting pressure on Pakistan to send troops to North Waziristan to fight Taliban who claimed responsibility for the recent failed bombing attempt in New York. The IMF announced its readiness to adjust Pakistan’s budget deficit and borrowing targets to let Pakistan manage necessary funding for such priority programs as security.

Portugal said, “these challenges highlight the importance of pursuing a credible fiscal consolidation, maintaining a flexible exchange rate and a cautious stance to monetary policy, and improving governance”.

IMF accepted Pakistan’s request to increase the end-June 2010 budget ceiling by 0.15 percent of gross domestic product, and the floor for net foreign assets of the State Bank of Pakistan was raised by $300 million.

Addressing a press conference State Bank of Pakistan Governor Salim Raza said inflation rate was reduced at 10.3 percent during the first quarter of current fiscal year.

SBP officials tell us the risks of inflationary pressures due to higher oil prices and electricity tariff adjustments and the high domestic financing needs of the government were the key factor guiding current policy. It is apparent that State Bank has “balanced its desire for a more forceful support of the fragile recovery with its concerns about external stability and liquidity pressures arising from the government’s large domestic financing needs,” say an official privy to the decision making process.

International economists believe that remaining inflation pressures and increased domestic financing of the public sector prevent the SBP from easing monetary policy to support growth.

Governor Salim Raza today said the inflation rate was reduced at 10.3 percent during the first quarter of current fiscal year and inflationary pressure is there due to the increase in commodity prices in international market.

State Bank projects inflation to remain 11 to 12 percent this year – substantially lower that 21 percent that country faced last year.

According to IMF, concerns about low economic activity, weak private credit demand, and lower y-o-y headline inflation point in the direction of an easing of the monetary stance. The SBP proceeded with a reduction of the policy interest rate of 50 bps in November. Staff would have given greater weight to inflation risks and preferred a more cautious stance.

The SBP discount rate was lowered from 14 percent to 13 percent in August, and to 12.5 percent in November, but real interest rates remained positive. The rate cuts were limited because of concerns about remaining inflation pressures, the fiscal slippage in the first quarter, and the availability of external financing.

Governor Salim Raza said Pakistan’s forex reserves are at $15 billion. He said, “the government will have to borrow more loan from banks on account of budget deficit.”

While the government’s domestic financing needs have risen due to shortfalls in external financing, bank credit to the private sector has declined despite cuts in the policy interest rate. At the same time, the government’s high borrowing requirements have pushed T-bill rates from just below 11½ percent in mid-July to 12¼ percent in November. Government borrowing was supplemented by the issuance of government-guaranteed Term Finance Certificates (TFCs) to regularize the debt of the electricity sector companies (circular debt). Significant liquidity injections by the State Bank of Pakistan (SBP) in August–October were made to help meet the financing needs of the public sector and the seasonally higher demand for currency, while keeping the overnight repo rate within the policy corridor.

Only 65 per cent Pakistanis have access to electricity and still demand has outstripped supply; the country is currently facing peak power shortages of approximately 4,000 – 4,500 MW.

To address the present electricity demand-supply gap, coupled with consistent growth in demand (7-8% per annum), Zardari government had proposed Rental Power Plant as an intermediate measure.

In August last year presided over by Prime Minister Yousuf Raza Gilani the federal cabinet approved installation of 14 rental power plants to generate 1,500MW to partially offset the overall deficit of 2,700MW. The remaining 700MW will come from the existing system. A total of 2,250MW of rental projects was approved.

The opposition politicians had described it as ‘a source of kickbacks’.

Pakistan government had asked ADB to analyze prospects of Rental Power Plant projects sponsored by the water and power ministry. According to reports, the ADB said is of the opinion that the government should execute only eight RPPs with a total generation capacity of about 1200MW.

Even at the reduced level tariff is likely to increase by 24 per cent, in addition to about 30 per cent increase in electricity rates as required under IMF loan agreement. About 18 per cent tariff increase has already been notified by the government under the IMF program.          

Pakistan has 19,420 Megawatts (MW) of total installed generation capacity from hydroelectric, thermal, and nuclear sources.1 Electricity is supplied mainly by conventional thermal plants, with oil and natural gas being the primary fuel sources. Thermal power plants account for around 66% of total capacity. A further 32% of the capacity is accounted for by hydro-electric plants, with the remaining 2% supplied by nuclear power stations. 

State Bank of Pakistan’s First Quarterly Report on the State of the Economy for current fiscal year said the real GDP growth is likely to be around annual target of 3.3 per cent; higher than 3 per cent growth projected by IMF last week.

International Monetary Funds has revised the inflation from 9 to 11 percent which reflects the rebound in the prices of fuel and a larger second round impact of the increases in electricity tariffs.

Higher remittances and other private transfers have resulted in an improved current account outlook, notwithstanding higher oil and other commodity prices.

The current account deficit is now projected at 4.2 percent of GDP, compared with 4.7 percent. However, the impact on the overall balance of payments will likely be muted by lower Tokyo-related disbursements.

State Bank’s report suggest that the prospects of returning to macroeconomic stability have improved in the initial months of FY10 as most of the key indicators continue positive trends that began in the closing months of the last fiscal year.

A combination of weak economic activity, a shift in the advanced income tax payments from September to October, lower grants, and lower-than-expected receipts from the Coalition Support Fund for reimbursement of certain military outlays resulted in a revenue shortfall of about 0.6 percent of GDP relative to the program target.

On the expenditure side, higher security spending, and the early payment of wages for October ahead of Eid contributed 0.2 percent of GDP to the slippage.

The authorities took several measures to contain the first quarter fiscal slippage. These measures included compression of spending on goods and services and investment and the mobilization of a transfer from the SBP equivalent to about ½ percent of GDP.

Spending in high-priority areas, such as the social safety net and assistance for IDPs, has been lower than expected. The rollout of the strengthened targeting scheme under the Benazir Income Support Program (BISP) continued to be challenged by the implementation capacity. As a result, spending under the BISP amounted only to Rs. 10.4 billion in the first quarter, compared with Rs. 14 billion projected under the program.

However, some additional social spending, mainly through subsidization of basic foodstuffs, was incurred by the provinces. Spending on IDPs was about two-thirds of the Rs. 15.5 billion (about 0.1 percent of GDP) budgeted for the first quarter of 2009/10, as the security situation in Swat stabilized faster than expected.

State Bank expects current account deficits to be between 4.7 per cent and 5.2 per cent.

The SBP discount rate was lowered from 14 percent to 13 percent in August, and to 12.5 percent in November, but real interest rates remained positive. The rate cuts were limited because of concerns about remaining inflation pressures, the fiscal slippage in the first quarter, and the availability of external financing.

In mid-August, the SBP introduced an explicit interest rate corridor of 300 bps and the SBP shortened the periodicity of monetary policy decisions from quarterly to bimonthly in order to facilitate more frequent adjustments of policy rates. Following the introduction of the corridor, fluctuations in the overnight repo rate have fallen significantly.

The SBP has also increased interest rates on its refinancing facilities, with a view to aligning them with market rates over the next two years. To this end, the interest rates on the Export Finance Scheme and the Long Term Financing Facility have been increased to 8 percent and 9.2–10.25 percent (depending on tenor), respectively.

In November 2008 the International Monetary Fund approved a 23-month Stand-By Arrangement for Pakistan in an amount equivalent to US$7.6 billion to support the country’s economic stabilization program. The total amount of the IMF resources made available under the arrangement equals 500 percent of the country’s quota. The arrangement was approved by the IMF Board under the Fund’s fast-track Emergency Financing Mechanism procedures.

The fiscal policies of General Musharaf’s rule (FY2007/08) had put the country at the brink of bankruptcy. The external current account deficit had widened to a record level; net capital inflows declined significantly, and currency depreciated substantially. A delay in the pass-through of higher international prices to domestic consumers led to a large increase in the fiscal deficit, and its monetization by the State Bank of Pakistan contributed to rising inflation and a sharp decline in international reserves. Pakistan was unable to secure funds from any other source so the IMF loan appeared to be a godsend.

It sounds funny but my Executive Producer was following this story so keenly that he woke me up in the middle of the night to say that the first installment had hit the country’s Central Bank.

Generally speaking there was no criticism – like a borrower with poor credit history who signs away their first born to a sub-prime mortgage, the Pakistani media blindly let it slide.

No one raised an eyebrow that the IMF required Pakistan to raise the power tariff by 24 percent during the current fiscal year in three phases – six percent in the October-December quarter, 12 percent in January-March and six percent in the April-June period. A 4.4 percent tariff increase was announced in October 2009, and now a notification is pending for an additional 13.6 percent increase.

IMF’s stated objective for this arrangement was two fold: “to restore macroeconomic stability and confidence through a tightening of macroeconomic policies; and to ensure social stability and adequate support for the poor and vulnerable in Pakistan.”

But this dual ‘objective’ is an oxymoron.

Like other developing countries, the government of Pakistan has been the leading source of employment and channel for capital. But market fundamentalists define governments as inefficient economic actors, and so prioritize reducing their economic role.

Austerity measures are imposed by raising prices of electricity and cutting other government provided subsidies so external debts (in our example IMF debt) can be paid back. Increasing electricity tariffs in Pakistan will eventually translate into layoffs and reduction of entrepreneur’s capacity to compete in global market.

Under the same IMF agreement, the State Bank of Pakistan has stopped selling foreign exchange to banks for financing crude oil imports and this results in a weakening of Pakistan rupees. Pakistan forex is also impacted by higher interest rates, another IMF condition that Pakistan had to swallow. Charging higher interest rates for credit is the classic way to control inflation and it fits well within the IMF framework.

But high interest rates are choking Pakistan’s economy: small and medium-sized businesses and farmers cannot afford credit, and so are often forced out of business. Pakistani farmers are forced to sell their land leading not only to less productive agriculture but environmental devastation.

Some would argue that higher interest rates attract foreign investment in government bonds. But at best these are short-term investments by profit-seeking investors. Pakistan’s experience under Musharaff/Quresihi tells us that short term investments have a destabilizing impact. The faster it comes, quicker it leaves.

The Kerry-Lugar Bill became an issue because it was aid to Pakistani people – directly to the civil society and it bypassed Pakistan’s army. It was made an issue by a handful of journalists and dropped like hot potatoes when GHQ told them to stop. It was aid- not a loan.

IMF’s sub-prime loan to Pakistan has conditions that impact life and livelihoods of ordinary citizens and no TV anchor, no mainstream journalist is willing to scrutinize this debt? I wonder why?

“Pakistan’s efforts need a much greater financial support from the international community,” Adnan Mazarei, the Fund’s Mission Chief to Pakistan, said.

He spoke to reporters following IMF’s approval last week’of a $1.2 billion tranche of $ 11.3 billion stand-by arrangement for Pakistan. The approval came as the Fund completed a review of the economic performance of Pakistan, marked by encouraging macro economic stabilization signs and structural tax reforms.

But IMF official claimed that Pakistan needs to cut some development and non-development spending and boost revenue collection. Mazarei said that uncertainties about the government’s financing needs are limiting the central bank’s ability to lower interest rates.

Pakistan, the second biggest South Asian economy, made some difficult decisions on tax reforms and considerably reduced inflation this year, while also continuing a high-stakes fight against Taliban and al Qaeda militants along the 1600-mile long porous Afghan border.

According to Finance Minister Shaukat Tarin, Pakistan’s ongoing fight against militancy is costing the country around $ 8.5 billion a year.

In the conference call, Mazarei particularly reminded the major economic powers of the need to step up realization of more than $ 5 billion pledges they made at Tokyo conference earlier this year.

“International donors need to disburse pledges they made to Pakistan in the April Tokyo Conference. They need to do so promptly because these disbursements are meant to finance much-needed investments in infrastructure, health, education (fields),” he stated.

Mazarei, who is Assistant Director in the Middle East and Central Asia Department at the Fund, noted while Pakistan still faces significant economic challenges, it has done pretty well by keeping things on track in various sectors of the economy – bolstering foreign exchange reserves and curbing inflation down to 10 percent from a high of 25 percent.

Mazarei said  “as inflation continues to decline, monetary policy could become more flexible and allow interest rates to come down further.”

IMF loan requires Pakistan to lower its budget deficit for the fiscal year ending June 2010 to 4.9% of GDP.

The government has to cut spending on some development projects that were meant to be financed by donor assistance, Mazarei said.

Total addressable market for the sale of sovereign bond in Pakistan is estimated to be as high as Rs500 billion.  By launching new investment instrument Government hopes to attract the excess money from the market that is not finding any productive outlet.

Savings bond will be sold through the network of the Central Directorate of National Savings and will be traded in the capital market.

Because of the lack of investment opportunities, experts feel that the prospective share price per unit of the government bond will higher than its face value.

The administration of Karachi, Lahore and Islamabad stock exchanges and the Security Exchange Commission of Pakistan have already received the draft rules and have very short window for comments.

General Manager of the Karachi Stock Exchange Haroon Askari was quoted in Dawn saying these bonds can “change fundamentals of our marketplace”.

Government backed bond will be ‘deemed listed’, which means that it will avoid the arduous procedure of application for listing and public offer before making its way to the market.

Government officials say they are actively pursuing the move to meet Pakistan’s budgetary demands.

As recipient of IMF loan, Pakistan is prohibited from the State Bank borrowing beyond certain limits. The World Bank and the ADB have also pressured Pakistani government to introduce investment opportunities and raise resources from market at competitive rates.

If this bond is ‘deemed listed’ next week, it will qualify Pakistan for the last tranche of $200 million under the ADB Accelerated Economic Transformation Project (AETP). Pakistan has been assured that the amount would be disbursed as soon as the bond is introduced during the current month.

The present measure has been adopted in the wake of Pakistan rupee losing 53 paisa or 0.6 per cent of its value within 4 days against the dollar as banks began to buy US dollars in advance. Bankers anticipate a further decline in the rupee value as they start financing crude oil imports. Crude imports stood at $4 billion or more than 40 per cent of the overall petroleum imports of $9.5 billion in FY09.

Pakistani bankers estimate this year’s crude imports around $3.5 billion if the global prices remain range-bound and local refineries’ output that declined eight per cent in July-November 2009 does not rebound quickly.(In July-October 2009 crude imports fell to a billion dollars from two billion dollars in a year-ago period due to reduced refineries’ production and lower international prices )

The banks in Pakistan need some $300 million per month to finance crude oil imports.  The rupee depreciated a bit immediately after last announcement and  it may lose some more value in next few weeks unless there are big inflows of foreign exchange.

After the talks between Pakistan and the IMF mission held in Dubai last month, the government is expecting $1.2 billion after the approval by the IMF board scheduled to meet on December 21-22.

But IMF’s Director of External Relations Department Caroline Atkinson has said discussions with Pakistan were in progress, implying that the Dubai talks were not final and that the release of the fourth trance of the $7.6 standby credit might be delayed.

If Pakistan does not get the fourth trance this month a steeper decline in the rupee value of rupees in anticipated in the last weeks of December.

Pakistani bankers also concerned that the year-end servicing of both sovereign and corporate foreign debts would keep the rupee under pressure.

Foreign debt servicing in October-December 2009 was estimated well above a billion dollars, the major share of which was paid in December. In July-September Pakistan spent $1.2 billion on foreign debt servicing despite a roll-over of $450 million.

In July 2008, the State Bank had decided to provide foreign exchange to banks for financing import of crude oil and petroleum products to keep the exchange rates stable amidst inconsistency  triggered by international financial crisis and recession. But it stopped providing foreign exchange for financing of import of furnace oil from February 2009 and for that of petroleum products from July.

Now it has stopped selling foreign exchange for crude oil as well—reportedly to meet one of the conditions of the IMF standby loan—thus restoring the pre-July 2008 arrangements wherein banks were responsible for arranging foreign exchange to finance imports of both crude oil and all petroleum products.

Between February 2009 and 10 December 2009, when banks started financing of furnace oil imports on their own, the rupee has lost 6.8 per cent of its value against the US unit. A senior State Bank official remarked. “This should remove fears that the shifting of financing of crude oil imports to banks would lead to a big depreciation in the rupee value,” He  also added  “The rupee might lose a bit but we neither foresee a major decline in its value nor a serious inconsistency in exchange rates.”

Bankers also dispel the possibility of a speculative attack on the rupee value saying the State Bank is yet to allow forward selling of foreign exchange to importers and thus the question of manipulating exchange rates does not arise. But they say the central bank may allow it sometime next year as the IMF is believed to have raised this issue during talks with SBP authorities.