ConunDARum: With IMF review delayed, Pakistan gives into China’s demand

With Pakistan desperate to make up for gaps in its external financing, the government has made a key move to signal where it expects the help to come from. A meeting of the Economic Coordination Committee (ECC) of the cabinet last week greenlit establishing a revolving fund account for independent power producers (IPPs) operating under the umbrella of the China-Pakistan Economic Corridor (CPEC). 

The timing is notable. Finance Minister Ishaq Dar had claimed that by early December the position of reserves would be stronger, that would be progress on the 9th IMF review, and that there would be a better macroeconomic environment. Most of this is still up in the air, and reserves continue to remain at a dangerously low level. 

The revolving fund marks a key concession from Pakistan which Beijing has been demanding ever since the first signing the original CPEC agreement eight years ago. China had pressed for such a mechanism as the circular debt issue plaguing IPPs in Pakistan had resulted in over $1 billion being stuck in arrears for Chinese companies. 

A prime reason for the delay had been because Pakistan finds itself in an International Monetary Fund (IMF) programme. The largest shareholder at the fund – the United States – has already expressed concerns about preferential treatment to Chinese companies on various forums.

However, good relations with China prove to be imperative as Pakistan’s external account problems continue to persist. As part of the ECC’s move, the title of the account has been changed from the Pakistan Energy Revolving Fund to Pakistan Energy Revolving Account. 

The interbank rate has stabilised as outflow controls, such as LC restrictions, have worked and demand has dampened. The demand in the open market is up, based on a quick profit making in the exchange market and is amplified by savers dollarizing their savings and people rushing to currency exchanges for foreign currency as travel has picked up.

Tahir Abbas, Head of Research at Arif Habib Limited, thinks Pakistan setting up a revolving fund for CPEC IPPs will help: “It will reduce the quantum of circular debt, which is actually what the IMF wants to do. This step will mean timely payments for CPEC power projects and its lenders, the Chinese.”

“To some extent, Pakistan can expect some form of inflows from China as this was one of the conditions the government finalised before the Prime Minister visited China.”

“This has been a hurdle in the approval of new investments from China, and will certainly help in improving flows from the friendly country,” says Fahad Rauf, Head of Research at Ismail Iqbal Securities. “This is part of a sovereign agreement, and Chinese IPPs are well within their rights to enforce this,” he adds. 

Rauf adds the IMF will not have a problem with this as long as the fiscal targets are met and circular debt is managed. Dar had said back in November that most of Pakistan’s external financing needs have been secured. Things were supposed to be normalising in early December on the back of inflows. Last week, during an interview on Geo News, Dar dropped the news that Pakistan would receive $3 billion from a “friendly country”. The finance czar, however, did not name the country.  

Earlier in November, Dar said Pakistan had to pay back $22 billion to meet multilateral and commercial liabilities over the next 12 months, and the current account deficit is projected to be around $10 billion-12 billion.

He added, “We have covered half the mileage…  Pakistan has secured financial commitments of around $13 billion to $14 billion, which includes commitments from China and Saudi Arabia,” he added. Pakistan’s FOREX reserves clocked in at $6.7 billion as of December 2 following a $1 billion payment against maturing Pakistan International Sukuk and other external debt repayments. Pakistan has recently received $500 million from the Asian Infrastructure Investment Bank (AIIB). 

The Saudi Development Fund also rolled over a $3 billion deposit that was to mature and be paid back this month. A rollover, however in this case means the funds will stay with Pakistan and does not mean a bump up in reserves.

In a podcast hosted by the SBP, the central bank’s governor Jameel Ahmad stated that Pakistan expects another $8.3 billion rollover for maturing obligations as discussions are underway.

The governor stated that the Government is also in talks with a friendly country for the disbursement of a $3 billion loan and negotiations with multilateral agencies are progressing, for further financial support. He did not mention the name of the country.

The Central Banker  added that the SBP repaid two commercial loans totaling $1.2 billion. “These banks are expected to refinance the same amount, in coming days, helping to raise the country’s foreign exchange reserves,” he adds. 

He added that Pakistan is having trouble raising funds from international financial markets due to the war in Ukraine, international commodity prices, and monetary tightening by central banks.

“So far Pakistan has received another $4 billion rollover from China earlier this year. It is important to note that $30 billion alone of Pakistan’s external debt is owed to China,” says Shahbaz Ashraf, Chief Investment Officer at FRIM Ventures, an investment company. 

Ashraf thinks the decision by the ECC to set up the fund will help bring inflows from China.

“While Saudi Arabia has announced an extension of its deposit, inflows may come in once Muhammad bin Salman visits Pakistan. KSA just announced $5 billion of safe deposits for Turkey, if they want they can extend the same to us too. If we do not get external debt, the situation will get dire. The currency will slip”, he adds. 

Dar had also gone on record claiming the rupee is undervalued and one dollar should be worth Rs 190. It stands well beyond Rs 220 – and that’s in the interbank. “The REER has reached 100 from 91. This implies the currency is fairly valued, if not overvalued. There are greater chances for the PKR to depreciate considering how Pakistan needs more debt to pay debt, remittances can further slow down, exports will slow down too, and inflation inching higher”, Ashraf says. 

While the rupee is no longer depreciating significantly against the dollar, the widening gap between the open market and the interbank remains a concern. There is usually a differential or spread between the two rates, primarily because exchange companies have margins so that they make money. In normal circumstances, the difference between the two rates is small. The difference between the two has grown, however, exacerbating the current currency situation.

Due to the current controls on outflows from the country, the rupee has withstanded significant depreciation. However, the controls on imports are to be undone in the near future. Babar during the podcast added that the SBP placed restrictions on imports mentioned in chapters 84, 85, and certain items of 87. He said these restrictions covered about 15 percent of Pakistan’s total imports whereas no restrictions have been placed on 85 percent of imports. Babar also claims that less than 10% of the country’s imports are currently subject to administrative controls.

Managing the rupee and reserves artificially through these restrictions will hinder talks with the IMF and therefore it is likely that the SBP will begin acting on it. Babar said all such restrictions are temporary and will be reversed. 

Meanwhile, the ninth review of the IMF programme, which is to release $1.2 billion, is facing significant delays. As per television reports on Express News, the last meeting between Pakistan and IMF officials was not very fruitful due to the latter’s call to comply with actions that were not due during the ninth review period.

According to a report by Shahbaz Rana, the IMF was unsatisfied with the revenue and spending plans shared by Pakistan and sought additional information. In the meanwhile, Dar went live on Shahzeb Khanzada’s show on Geo to state the IMF is behaving “abnormally” and that he “won’t take dictation” from the IMF. He also said he “didn’t care” if the IMF delegation was not visiting as per schedule. 

The first working day after Dar’s interview, the stock market closed in the red as investors booked profit. The bourse bled 537 points, down  1.27% in a day, closing at 41,612.67 points after posting an intraday low of 41,514.81 points.

“The review needs to go well. However, before that measures such as a mini-budget, some revenue measures such as gas tariff hikes, and sales tax imposition on petroleum products need to happen. 

Ashraf however points out that while everyone is talking and focusing on the Current Account Deficit (CAD), a prime concern should be the financial account. “The CAD is being managed. Out of the total funding gap, around 70% alone is debt obligation; while the CAD is just $10 billion this year. If the CAD is lower or further managed economic growth will suffer; while external debt will haunt all governments to come in the future.”

Ashraf adds, “Currency can only stabilise if we reschedule our foreign debt or political stability prevails. Our total foreign debt is around $100 billion billion and the payment required in the next three years is around $65 billion. By the looks of it, Pakistan needs $15 to $20 billion debt from the IMF. However, it is unlikely for any political party to opt for such a massive IMF programme due to political ramifications.”