“Default” risk recedes as IMF announces staff level agreement with Pakistan

“Default”

risk recedes as IMF announces staff level agreement with Pakistan

Fund warns of lurking dangers as turbulence grips global financial markets

Amuch-awaited staff level agreement was announced by the IMF on July 13, but the statement carried dour warnings of significant challenges ahead. Most importantly, Pakistan’s projected external financing needs for FY 2022-23 were $35 billion as per the IMF Staff Report issued in February of this year.

The next step now is approval from the Executive Board, which has yet to be scheduled. “The board meeting can follow….any time between three, six weeks, within that period could be slightly earlier, could be slightly later, could fall within that, but that’s roughly the ballpark between the staff level agreement and then the final agreement, which comes from our board,” the Fund’s spokesperson, Gerry Rice, said in a briefing to the press on Friday. According to data from finance ministry sources, FY 2022-23 will see loan repayments of $21 billion and a projected current account deficit of $12 billion. Coupled with building reserves of up to $5 billion, the external financing needs could be around $38 billion. In his pre-budget press conference, Finance Minister Miftah Ismail said “we need $41 billion over the next 12 months” to cover the CAD and amortisation payments as well as build reserve cover to three months of imports by end of FY 2022-23. But this figure could include payments in the month of June 2022 as well, and may not reflect external financing needs for FY 2022-23.

The statement just released says only that Pakistan faces “higher financing needs in FY23”, implying that this figure is likely to be revised upward by the time the Memorandum on Economic and Financial Policies (MEFP) is released following board approval.

Some confusion surrounded the numbers reported by the IMF on the primary balance target for end FY 2022-23. The Fund statement said the programme targets “an underlying primary surplus of 0.4 percent of GDP” by the end of FY 2022-23. Astute observers noted, however, that the government’s own budget documents gave a figure of 0.2% of GDP for the size of the primary balance by end FY 2022-23.

Speaking to Profit, Ismail said there is a simple explanation for this. “The Fund is talking about the underlying fiscal balance,” he said. “This is subject to adjustors for one-off payments that need to be made during the fiscal year. This year we will have around Rs 180 billion to pay to the IPPs, which are one-off payments and subject to these adjustors. Hence, the actual primary balance, after accounting for the adjustors, will be 0.2% of GDP.”

The Staff Report from the Sixth Review completed in February 2022 reports the underlying primary balance as 0.8% of GDP for FY 2021-22, and the primary balance as 0.3% of GDP. For FY 2021-22, payments related to IPPs arrears clearance and Covid spending were excluded due to their one-off nature. “The amount subject to adjustors was Rs630 billion in FY22,” said Ismail. The announcement released early morning on July 14 points to significant risks ahead. This was the first working day after the Eid holidays and financial markets saw significant turmoil. Risk premiums on Pakistani bonds skyrocketed, the exchange rate dipped and yields demanded by banks in the first T-bill auction since last week’s 125 basis point hike in the policy rate also climbed relentlessly.

London-based bond traders and analysts tell Profit the spike in risk premium on bonds is not Pakistan specific but is happening across emerging markets, especially high yield ones, on the back of further interest rate hikes by the US Federal Reserve as the latest data showed inflation crossing 9% in the United States. Markets expected further rate hikes by the Fed, fueled by a 100 basis point hike by the Bank of Canada on July 13.

Rate hikes in advanced industrial economies suck capital out of riskier emerging markets as investors fly into the relatively safer higher yields on offer in those jurisdictions.

On Thursday, these premiums were inching down as confidence slowly seeped back following the Fund’s announcement. Bloomberg reported the Sukkuk maturing in December 2022 rose to 90.4 to a dollar after dipping to 89.5 a day earlier, while the April 2031 maturity also strengthened by 0.2 cents. But by Friday they had begun climbing again.

Wednesday, July 13, also saw the exchange rate drop to PKR 211 to a dollar in both the interbank and open markets, dipping by PKR 2.20 and PKR 2.50 in each respectively. On Thursday both opened at PKR 210.3 and PKR 209.5 respectively. But by Friday both closed at or above PKR 211.

Yields demanded by banks also spiked on Wednesday in the first Treasury Bill (T-bill) auction to be held since the policy rate hike of last week. Profit carried the story earlier.

As the Fund programme moves towards resumption, the schedule of disbursements has been revised to reflect the possible extension till June 2023 as well as a possible enhancement of disbursements by $1 billion. The Fund statement points towards both domestic as well as global pressures for why Pakistan is in need of a bailout.

“A difficult external environment combined with procyclical domestic policies fueled domestic demand to unsustainable levels,” it says. The prolonged period of negative real interest rates, that had to be unwound in a rush via a 775 basis point hike in the policy rate since November 2021, provided a strong impetus to growth but also gave rise to pressures on the external account that depleted the foreign exchange reserves and placed great pressure on the exchange rate.

“The resultant economic overheating led to large fiscal and external deficits in FY22, contributed to rising inflation, and eroded reserve buffers,” adds the statement.

Going forward the government is expected to return a primary surplus of 0.4% of GDP in its fiscal balance by the end of FY 2022-23, which will require strong revenue performance as well as tight expenditure control. Stemming the continued growth in the circular debt, expected to see a flow of PKR 850 billion in FY 2021-22 according to the Fund statement, is another priority singled out for mention. It also calls for “proactive monetary policy” which responds strictly to inflation and “greater exchange rate flexibility”. The staff report from February 2022 pointed specifically to interventions in the foreign exchange market. “The volume and frequency of FX intervention and other administrative measures have been increased to manage the FX market as current expansionary macroeconomic policies led to heightened depreciation pressure on PKR in 2021,” said the report. Once the programme resumes following board approval, the practice of import restrictions via bans and cash margin requirements as well as administrative processing delays will need to end.

The State Bank will need to acknowledge the higher yields demanded by banks in

T-bill auctions as a market reality rather than an avaricious practice to be stamped out. Power and gas tariffs will need to rise sharply to curtail the continuing flow of circular debt. In short, more interest rate rises, further currency devaluation and higher utility bills await the business community as programme implementation gets underway in earnest. n