Pakistan Promises IMF to Raise Rates If Reserves Drop and Eliminate Electricity subsidies

By Michael Dwyer and Khalid Qayum

December 3 2008

Pakistan’s central bank promised the International Monetary Fund as part of a $7.6 billion bailout that it will increase interest rates further if the nation’s foreign reserves drop too low.

The State Bank of Pakistan said its benchmark rate “will be raised earlier” than the monetary policy statement due at the end of January 2009 if reserves fall below an agreed monthly floor, according to the loan arrangement between the IMF and Pakistan. The Washington-based lender posted the agreement on its Web site.

Pakistan, denying blame for last week’s terrorist attacks in Mumbai, was forced to turn to the IMF for a bailout after its foreign reserves shrunk 75 percent in a year to $3.45 billion. The IMF fell short of saying when it would allow restrictions on share trading to be removed, upsetting some investors who are awaiting the implementation of a 20 billion rupee ($255 million) government fund to help lift stocks.

“The stock market should be opened to allow free movement of capital,” said Farid Khan, director of equities at Credit Suisse Pakistan Ltd. in Karachi. “Focusing on the foreign- reserve position, while important, can damage the capital market and foreign investment.”

The Karachi Stock Exchange has prohibited investors from selling shares below their Aug. 27 closing prices, after the benchmark index fell 35 percent earlier this year. Ending the ban and “the use of public funds to support the stock market will be decided after reaching understandings with Fund staff,” the IMF said.

‘Tightening’ Policies

Pakistan’s economy may expand as little as 3 percent this fiscal year in response to a “tightening” of macroeconomic policies and a deceleration of growth in the nation’s trading partners, the IMF said. That would be the slowest pace since 2000, when South Asia’s second-largest economy grew 2 percent.

In order to secure the IMF loan, Pakistan’s government and central bank have also agreed to eliminate electricity subsidies by the end of June 2009 and to continue to adjust fuel prices to reflect international prices. That should reduce the budget deficit as a proportion of gross domestic product to 3.3 percent by 2009-10 from 4.2 percent in 2008-09 and 7.4 percent this year, the IMF said.

“Many of the major targets set by the IMF, including reducing the fiscal deficit and maintaining foreign reserves will bring discipline to the government,” said Samiullah Tariq, head of research at InvestCapital & Securities Ltd. in Karachi. “The IMF conditions aim at lifting the control of the government and the central bank over the fiscal targets.”

Interest Rates

The central bank’s net foreign-asset floor for the end of December, a breach of which would trigger the commitment to increase interest rates, has been set by the IMF at $1.165 billion. The level for March 2009 has been set at $671 million.

“Interest rate policy will be sufficiently flexible to protect the reserves position and bring down inflation,” the IMF said. “The program envisages a significant tightening of monetary policy.”

Governor Shamshad Akhtar on Nov. 12 raised the central bank’s key rate by 2 percentage points to 15 percent, describing the move as “the toughest decision of my life.” Inflation accelerated to near a 30-year high in October, with consumer prices soaring 25 percent from a year earlier.

The IMF has approved more than $40 billion of loans in recent weeks to prevent the global financial crisis and recession from undermining the stability of developing nations. Ukraine, Serbia and Iceland have already got funds from the IMF. Belarus has requested $2 billion and Turkey may also agree to emergency funding.

Pakistan completed its last IMF program in 2004 with a credit rating from Standard & Poor’s of B+, four levels below investment grade. S&P cut the nation’s rating to CCC on Nov. 14, one day before the latest IMF loan was announced, citing a risk of default on external debt payments.

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Pakistan Obtains $7.6 Billion Bailout Loan From IMF

By Khalid Qayum

November 25 2008

Pakistan obtained a $7.6 billion bailout from the International Monetary Fund to help prevent the country defaulting on its debt.

The State Bank of Pakistan, which this month raised its benchmark interest rate to 15 percent from 13 percent, has committed as part of the aid to “further tighten monetary policy as needed,” the IMF said in a statement in Washington yesterday. South Asia’s second-largest economy will be able to immediately draw upon $3.1 billion of the loan, it said.

President Asif Ali Zardari, facing pressure from the U.S. to step up the fight against Taliban and al-Qaeda insurgents along the border with Afghanistan, needs IMF financing to prop up Pakistan’s ailing economy. The nation’s foreign-exchange reserves have shrunk 75 percent in 12 months to $3.45 billion and economic growth is forecast to slump to a seven-year low.

Pakistan’s rupee gained 0.44 percent against the dollar to a seven-week high of 78.70, as of 11:15 a.m. in Karachi. The currency has declined as much as 26 percent this year as foreign investors spooked by the global credit crunch withdraw funds from emerging markets. The yield on the benchmark 9.6 percent bond due August 2017 held at 15 percent.

The loan from the IMF “will ease constraints on foreign currencies and it will boost the confidence of overseas and domestic investors,” said Samiullah Tariq, an economist at InvestCapital & Securities Ltd. in Karachi. “Now investors know that there will be a lot more fiscal discipline.” He said he expects rupee to strengthen to 75 against the dollar in a month.

Global Recession

The IMF has approved more than $40 billion of loans in recent weeks to prevent the global financial crisis and recession from undermining the stability of developing nations. Ukraine, Serbia and Iceland have already got funds from the IMF. Belarus has requested $2 billion and Turkey may also agree to emergency funding.

“The Pakistani economy was buffeted by large shocks during fiscal year 2007 and 2008, including adverse security developments, higher oil and food import prices and the global financial turmoil,” said IMF Deputy Managing Director Takatoshi Kato. “By providing large financial support for Pakistan, the IMF is sending a strong signal to the donor community about the country’s improved macroeconomic prospects.”

Pakistan expects the IMF loan will help it win additional aid from a group of other lenders and donor nations, including the U.S., U.K., China and Saudi Arabia. The group’s Nov. 17 meeting in Abu Dhabi adopted a “work plan” for financial help to Pakistan, the Foreign Ministry has said.

‘Significant Tightening’

To secure the IMF loan, Pakistan agreed to a “significant tightening of fiscal policy” and an end to central bank financing of the government. Pakistan plans to reduce its budget deficit to 4.2 percent of gross domestic product in 2009 from 7.4 percent in the past financial year, according to the Washington-based lender.

The cost of insuring a $10 million Pakistani government bond against the risk of default has more than doubled since the end of September to $2.28 million a year from $987,000 per annum, according to CMA Datavision.

Last week Pakistan’s government said the country’s $150 billion economy was expected to expand 4.3 percent in the fiscal year ending June 2009.

Growth is easing after central bank Governor Shamshad Akhtar on Nov. 12 increased interest rates by the most in more than a decade to curb inflation, which jumped to a 30-year high of 25.33 percent in August.

Pakistan completed its last IMF program in 2004 with a credit rating from Standard & Poor’s of B+, four levels below investment grade. S&P cut the nation’s rating to CCC on Nov. 14, one day before the latest IMF loan was announced, citing a risk of default on external debt payments.

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