Funding; but no funds

Power infrastructure gap is there; private sector is keen to invest and banks are willing to finance; but there is no funding. SBP from backdoors is reluctant to allow willing commercial banks to finance commercially viable projects in power sector by private sector including KE, groups such as Lucky, and Nishat.
The central bank urges big groups to get financing from abroad for their power projects including those on coal despite the fact that domestic banks are eager to get exposure. Why is this happening? It’s simple, for power projects the plants and machinery ought to be imported and the importers will buy dollars from local market. That can put rupee under pressure and foreign reserves would deplete.
Already machinery imports have become the highest component in imports bill surpassing petroleum imports in 7MFY16 - it’s at 2.8 percent of GDP in FY15 - highest in five years. It’s likely to jump of further and may hover around 3.5-4 percent of GDP in FY17-18. That is an encouraging statistic as higher machinery imports means that it will fill in the wide infrastructure gap in roads, railways, energy and other sectors. Plus, that may result in expansion in key industries including those related to construction (cement and steel).
But what all the movers and shakers of economic policy in Pakistan are thinking, to build as much foreign reserves as they can till 2018 election and to not let currency depreciate by then.
That is why the central bank is urging private sector to seek foreign funding for power projects financing. However, it’s a flawed policy and escapism from the ground realities. As once the projects are online, their revenue stream is going to be in rupee while the re-payment will be in dollars assuming all the financing is foreign.
There will be pressure on currency then and reserves may well start depleting. But that time is far and it would be the pain for finance minister and State Bank’s Governor at that time. What if the oil prices are high then? What if the infrastructure expansion would not be able to generate export surplus? We have seen that last cycle of industry expansion had not generated any meaningful exports surplus.
Do we really need so many energy projects as planned by government, Chinese investors and domestic private sector? Government might be thinking to trim the number of projects that are in planning stage. Whether that is the case or not; it’s crystal clear that the policies are to facilitate government and Chinese power projects and are discouraging private sector to invest.
For instance, RLNG plant of 1200MW by Punjab government in Bhikki got funding of Rs80 billion from National Bank and Habib Bank and similarly another project of RLNG by federal government is being entertained by local banks. There is all kind of facilitation for coal and gas based projects envisaged by Chinese under CPEC. However, the private sector is not really welcomed. That is essentially creating a monopoly situation for government by excluding the competition from private sector. Is this the pro-privatizing policy of PMLN?
If banks are not really allowed to lend to the private sector what is the point of lowering interest rates - just to reduce the cost of government borrowing? Does having low interest rates regime under the circumstances qualify as expansionary monetary policy?
Anyways, when the local groups go on the door of foreign banks for financing; only a few with high reputation are entertained. And in case of coal, no western financial agency is interested to finance it owing to environmental concerns.
And if they get financing, the rate that is being offered to best projects by top groups is nothing less the LIBOR plus 600 basis points based on the high risk rating of Pakistan. However, NEPRA is not allowing tariffs on any rates higher than LIBOR plus 450 bps. How on earth can private sector get foreign funding on power projects?
When the sovereign government issues bond at fixed rates of 8.5 percent for ten year bond; its next to impossible for private sector to strike a deal at LIBOR (which at around 0.5%) plus 4.5 percent for floating bonds. Yes floating rates are lower than fixed rates especially in low interest rates environment because the interest rates movement is inherently hedged. But the difference is marginal and banks are benchmarking Pakistan’s projects risk premium at 600 bps over LIBOR simply based on the rates of government bonds.
The private sector has put up their case in front of authorities and NEPRA may revise its limits upwards to let the private sector get foreign financing for projects. Is it a great idea? Certainly not; what would happen when LIBOR reached around 4-5 percent and oil prices are high.
That is a probable scenario 3-5 years down the road. The repayments will be too high but will be indexed and fuel price is also a pass on item. Who would bear the entire burden? The consumers of power in Pakistan who pay hefty tariffs on electricity. What if the reserves’ import cover is low by that time and circular debt is high due to growing gap between cost of production and that being charged by power producers?
An alternate and better solution could be to borrow from foreign avenues at fixed rates. That is to build cushion against higher machinery import bill by power sector and let the private sector to find funding from domestic commercial banks.
Government has the best of times for facilitating expansions as reserves are all time high and import cover of foreign reserves is over 5 months. Please do not waste it based on myopic approach of merely looking at 2018 elections. It’s time to think big and beyond winning election!