Pakistan: Will IFIs Bailout Stem The Default?

But as the government struggles o establish its credibility will the bailout package work? Or will it just enlarge the drain on resources? Much will depend on how quickly the government can establish a good rapport with business, industry, as will domestic and foreign investors.

The Worlds Bank, Asian Development Bank, Islamic Development Bank, United States, and Pakistan's Western and Muslim friends will provide this amount, just now. But the assistance may exceed the amount with more pledges, the government expects. But stringent conditionalities go with the cash which means considerable belt tightening for the government and the people of Pakistan.

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World Bank will provide $1.4 billion, Asian Development Bank $1-1.50, Islamic Development Bank will raise its trade finance from $ 500 million to $ 1.0 billion.

The United States has pledged a separate $900 million assistance which is in the pipeline and will be disbursed during the new American fiscal that started October 1. Negotiations for finalising these agreements are now underway.

Ministry of Finance officials says “as a result of these arrangements our financing gap of $4.5 billion will be bridged, and there is hope that the amount will move even somewhat beyond that level.”

The negotiations for this assistance carry stipulate that Pakistan will have to reduced its fiscal deficit which was 7.7 per cent in fiscal 2008 that ended June 30, to 4.3 per cent in the current fiscal 2009. In order to shore up its tax revenues, Islamabad also has agreed to reform its tax policy, and tax administration to plug the loopholes as the country has a significant potential to collect more revenues. It will place tax-to-GDP ratio at 15 per cent of GDP lover a span of five to seven years.

The government and the State Bank of Pakistan (SBP) the central bank will tighten monetary policy. The government will also reduce its heavy borrowing from the SBP which it is doing in order to meet the budget deficit. This borrowing is proving to be inflationary, and defeating the purposes of the current tight monetary policy.

The official forex reserves dropped to $7.3 billion. The amount includes $3.98 billion reserves held by SBP while the commercial banks hold $3.23 billion. But out of the SBP-held $3.98 billion, $1.5 billion have been utilised as forward booking liabilities, which leaves just $2.48 billion with SBP, according to the Ministry of Finance.

The forex reserves have declined fast in the last 11 months. The overall liquid forex reserves held by the SBP were $16.5 in October 2007. The amount had included $13.804 held by the SBP and $2.275 billion held by the commercial banks. The reserves had started receiving a big hit soon after, as prices of imported oil, food, and commodities soared.

The dollar was valued in the range of Rs62-65 for for long time, but the Pakistani currency's depreciation raised the greenback to a worrying Rs85.50 but some dealers quoted even Rs87.20 in the open market this weekend.

Bankers say people are buying dollars to protect the value of their assets, while panicky importers are booking dollars in advance to keep import prices within manageable margins. “The demand for dollars, both from businessmen and private customers is strong, and it appears that it will remain so,” says a senior bankers dealing with forex operations.

Last week, the central bank injected $100 million into the market to stop the rupee's depreciation. But the market reports that the actual amount was $200 million, inclusive of $50 million injected by the commercial banks on SBP's urging. It had only a marginal, and transitory effect on the health of the rupee. The rupee, soon after, started going down again.

The central bank HAD provided greenback at Rs80 to a dollar to banks and forex companies, which coupled with improvement in the reserves brought the dollar down to around Rs79.15. At one point during the week the dollar ghad come down to Rs78.90. The sale at this rate lasted a couple of days which had to be terminated because the SBP did not wish to use more of its cash. The demand was in fact, too much to have been met in any case.

A $500 million assistance from ADB last week did help shore up the market outlook a good deal. “This is the fist instalment of a $1.5 billion loan designed to support our economic development,” SBP spokesman said. The cash will top up Pakistan's foreign currency reserves and help improve confidence in its depreciating currency. And, it worked to boost the rupee. But the government is now of the view that with a decline in the price of imported oil, the present inflow from ADB is “valuable” and so will be the impact of the potential availability of assistance from Muslim and Western countries, an International Financial Institutions (IFIs). This is despite the fact that the trade and current account deficits are widening.

The Ministry of Finance (MoF) had projected a $14 billion current account deficit for the current fiscal 2009. Depending on the price of imported oil and food, and industrial inputs the amount may vary.

But so for, the depletion of forex reserves are impacting the domestic banking, squeezing banks' liquidity and undermining their capacity to lend. This is particularly important because the cotton harvesting season that started October 1, requires a huge amount of credit disbursement for the cotton to move from farmers to ginners, middlemen, and domestic textile mills who buy the fiber.

The cotton funding operation, which will last nearly six months involves funding of exports, too, if surplus cotton is available to be sold abroad. The liquidity crunch led overnight inter-bank lending rates to rise to a record high of 40 per cent early in the week. But it declined to 27 per cent after SBP intervention and injection of Rs53 billion into the market a day later. Sill later it came down to 16 per cent. It will come down further as a result of SBP allowing an injection of Rs270 billion that started on Saturday.

The key reason for this liquidity crunch is the decline in Pakistan's forex reserves. It led to a decline in the net foreign assets of the banks to Rs167 billion, compared to a Rs24 billion decline at the same time last year. As a result, credit to the private business in the busy first quarter - July-September - of the fiscal 2009, has risen merely Rs29.3 billion.

The liquidity is also being adversely affected as the government continues borrowing heavily from the central bank to meet its budgetary deficit. Its first quarter borrowing was Rs173.2 billion, up from Rs85.7 billion in the like quarter of 2008. This is despite the SBP warning to the government to stop borrowing more because it is adding to inflation. On the other hand, the government insists that it has to borrow from SBP in order to foot the bill for increased consumer subsidies on imported oil and food.

Speculation and rumours about confiscations of forex accounts and bank lockers is the cause of the travails of the Pakistani currency, and worries of the people. However, according to their current practice, the commercial banks in Pakistan keep their funs abroad with their head office in case these are Pakistani branches of foreign banks, or with corresponding bank in other cases. Therefore the government or SBP cannot freeze foreign currency accounts of Banks in Pakistan, or Pakistani customers having forex accounts in Pakistani or foreign banks. This is banned under Pakistan's Presidential Ordinance issued in 2001, the Chief Spokesman of the SBP said, in order to curb reports that the government or SBP may freeze forex accounts to tide over the present depletion of dollars. “The SPB or the government cannot freeze any forex account, according to the Presidential Order 2001,” SPB's chief spokesman Waseemuddin said.

While IFIs and Western and Muslim friends have been helpful, Standard & Poor's, last week lowered Pakistan's foreign currency debt rating to “CCC-plus” from “B” but still several notches above a level which will indicate default. Pakistan's local currency debt rating was lowered to “B-minus” from “BB-minus.” The country is expected to pay a total of $3.0 billion debts next year.

At the same time, Moody's Investors Service last month cut its outlook on Pakistan's debt to “negative” from “stable” referring to similar reasons. But it maintained its ratings at “B2.”

The bailout will help Pakistan, but the government has to up its own domestic act and policy together in order to build foreign and domestic investor confidence, and improve external balances to out its economy and the rupee back on track.