Debt disorder

SBP has kept the policy rate unchanged at 21 percent. It was as per market expectations. SBP expects, so does the market, that inflation peaked at 38 percent in May, and it will slowly taper off due to high base effect and softening commodity prices. However, there are risks such as the IMF programme not reaching a deal and disorderly debt restructuring. In that case, the currency can slip, and inflation can get out of hands.

In that case, nothing much can be done with the monetary policy. Tightening has its limits. Private credit is down by 7 percent in the last 12 months. The demand generation is by the government of Pakistan which is not responding to interest rate increase. But there are some improvements – the primary deficit is down from 3 percent of GDP last year to an expected 0.5 percent this year, and a marginal surplus next year. A stronger response by budgeting a higher primary surplus could have been better to contain inflation, which is averaging at 30 percent this year. But we are not living in a sane political world.

The juicy part of the policy was in the analyst briefing. Here majority of questions were regarding the external repayments and possible debt restructuring that has created quite a stir in the media and markets after Finance Minister’s recent media talks on the subject.

In the immediate term, Governor has given the comfort to the analysts’ community that out of $3.6 billion principal payment due in June, $400 million is already paid. And out for the remaining $3.2 billion, $2.3 is going to be rolled over and net payment would be $900 million. The SBP forex reserves at the start of June were $3.9 billion and that would be reduced to $3 billion by the end, net of principal debt repayment.

However, June has more to demand. It’s the financial year end and there are coupon and lumpy interest payments on loans. The toll is expected to be $450 million and that to be recorded in the current account. Given the rest of the current account to be in balance (as is expected in May), the forex reserves to be down to $2.6 billion by June end in the absence of any further inflow.

That is why further delays in the IMF could be detrimental. And unsuccessful conclusion of the IMF programme raises probability about debt restructuring request at the time of the next IMF programme negotiations. Here the Governor is saying that they don’t have any information while the debt restructuring consultants and banks are pitching their services in Islamabad for a few months.

The ideal world is to have debt reprofiling to convert $10 billion short term debt/ deposits to long term loans and have an equivalent amount of solid investment commitments. That would steer away from the crisis. And in that case, the gross financing requirement for the next IMF programme has to be met. The expectations of inflation to taper off would come true with stabilization of currency.

The flipside is scary, where external debtors have to sit for restructuring, and they would ask to bring domestic creditors on table as well as have higher share in the government debt. If external debtors take the haircut, then they would demand the same for their domestic counterparts. Upon inquiring about this scenario, the Governor firmly replied, “Domestic debt restructuring is out of the question”.