The IMF leash

The mandated fourth quarterly review under the International Monetary Fund's (IMF) Extended Fund Facility (EFF) remains inconclusive ostensibly because of the delay in sale of 10 percent of OGDC shares, issuance of Sukuk bonds as well as the decision not to raise power tariffs - time bound conditions that had been agreed with the Fund. The reasons for delay given: the ongoing sit-ins in Islamabad.
These decisions were delayed, so argue government stalwarts, because the dharnas created political uncertainty that would have naturally sounded alarm bells for prospective buyers of OGDC shares and sukuk bonds; raising electricity rates, they argued, would have swelled the ranks of the disgruntled within the country. Finance Ministry sources however recently indicated that OGDC share and sukuk bond sale would proceed soon, with only a slight delay from what was originally envisaged, while electricity tariff rise is not going to be implemented.
OGDC sale is expected to generate around 813 million dollars (around 829 billion rupees if the exchange rate of 102 rupees to the dollar is used) as per newspaper reports. In March 2014 the government, with 85 percent shares of OGDC with around 10 percent expected to be put on the market, had indicated it expects to generate 998 billion rupees at the then prevailing price.
Sukuk bonds were budgeted to yield 49.5 billion rupees. However like his predecessors the Finance Minister's budget data becomes irrelevant almost the next day it is presented to parliament - an example being the sale of 2 billion dollar Eurobonds (made possible by giving an interest rate more than double what was the prevailing in the West). It is therefore unclear how much the government would borrow through sale of sukuks. Sources in the Ministry of Finance have revealed that the agreement with the Fund is that 1.9 billion dollars would be realised through sale of OGDC and sukuk which would imply that either sukuk bonds would take up the slack and/or more than 10 percent OGDC shares would be put on the market.
A current account deficit due mainly to a rising export import gap would require 2.6 billion dollar gross financing needs, or so stipulated the IMF in its third review. Thus there would be a shortfall of 700 million dollars with 555 million dollars expected to be met with the release of the fourth IMF tranche (pending) and the rest through borrowing from other sources. Failing to meet any of the above conditions focused on generating revenue to meet the budgeted expenditure would require a mini budget that would include (i) reducing power subsidies which the government has indicated it would not implement due to political compulsions; (ii) raising revenue through indirect taxes rather than implementing tax reforms though Dar has announced a cosmetic measure namely setting up yet another tax reform commission). What is however more likely is enhanced reliance on short term much more expensive borrowing from where ever Dar can find it - internationally or domestically!
The government has obviously allowed political constraints to outweigh economic constraints - reminiscent of the PPP-led coalition government - and like its predecessor, has been unable to improve the performance of the energy sector after fifteen and a half months. The receivables today are higher than during the tenure of the PPP-led coalition government in spite of tough talk by Abid Sher Ali, the power hike is estimated at 33 percent with average bills rising by 42 percent, receivables have risen from 90 to 80 percent while distribution losses have declined by only 0.5 percent according to independent government data collected by Musaddiq Malik, the Special Advisor to the Prime Minister on Energy. Unfortunately the Prime Minister and Dar have rejected this data and have instead focused on over-billing during July and August alone that had created unrest in several cities.
The sector that remains of most concern to the general public is the power sector. The IMF conditions with respect to this sector have not varied - be it the 6.64 billion dollar Extended Fund Facility (EFF) signed in 2013 September or the 7.6 billion dollar 2008 Stand-By Arrangement (SBA) that lapsed due to PPP's refusal to implement the agreed power and tax sector reforms.
While one would assume that Dar's control over the power sector is proportional to what the Prime Minister allows him to do yet the Federal Board of Revenue operates directly under his Ministry. He has been unable to improve the tax structure and reliance on indirect taxes continues with many of his budgetary withholding taxes either challenged in courts of law or simply not being collected by newly designated withholding agents. Examples are advance tax on interest income and dividends versus taxation of accounting income; and airlines' inability to collect advance tax on first and business class tickets.
The question as to the difference between SBA and EFF merits a response. According to the IMF website the SBA is the workhorse lending instrument for emerging market economies, and is designed to assist the borrower overcome balance of payment problems, with a short-term duration of between 12 to at maximum 36 months. Each disbursement is repaid in eight equal quarterly instalments. SBA supports policies designed to help the borrower emerge from crisis and restore growth. However post-2009 a new SBA framework was developed by the Fund that envisaged the elimination of structural performance criteria and progress in implementing structural measures that are critical to achieving the objectives of the program; and instead assessing the performance of the borrowing country in a holistic way, including via benchmarks in key policy areas, in the context of program reviews. Thus SBA post-2008 would have enabled the government to negotiate on conditions in a more holistic way.
An EFF is a longer engagement with repayment between 41/2 to 10 years in ten equal semi-annual instalments. Extended arrangements would normally be approved for periods not exceeding three years, with a maximum extension of up to one year where appropriate. However, a maximum duration of up to four years at approval is also allowed, predicated on, inter alia, the existence of a balance of payments need beyond the three-year period-the prolonged nature of the adjustment required to restore macroeconomic stability-and the presence of adequate assurances about the member's ability and willingness to implement deep and sustained structural reforms. In other words less condition flexibility for a longer time period is associated with EFF relative to SBA.
However, the lending rate for both SBA and EFF is at non-concessional rates and are tied to the IMF's market-related interest rate which is itself linked to the Special Drawing Rights (SDR) interest rate. Currently the basic rate of charge amounts to the SDR interest rate plus 100 basis points. Large loans carry a surcharge of 200 basis points, paid on the amount of credit outstanding above 300 percent of quota. If credit remains above 300 percent of quota after three years, this surcharge rises to 300 basis points, and is designed to discourage large and prolonged use of IMF resources. A service charge of 50 basis points is applied on each amount drawn.
Sources within the PPP as well as in the IMF have revealed on condition of anonymity (reflective of PPP support) that ongoing discussions on structural reforms between the Fund and the PPP-led coalition government a few months before its term ended on 16th March 2013 focused on much less stringent conditions than agreed by the Federal Finance Minister Dar under the EFF.
It is moot to consider whether the PPP government was negotiating another SBA, short term but more flexible in terms of reforms, as opposed to Dar's focus on long term as opposed to short term loans that was highlighted in his budget speech on 6 June 2014: "medium-term debt management strategy (2014-18) has been developed to lengthen the maturity profile and reduce the refinancing risk along with sufficient provision of external inflows to relieve the pressure on domestic resources and to enable the private sector to access more credit from the banking system." Unfortunately the refinancing risk does not take account of the exchange risk. Dar on the instructions of the Prime Minister is committed to keeping the rupee between 98 to 100 per dollar (a decision that accounts for the IMF third quarterly review to maintain that "the authorities do not share staff's view that the exchange rate is somewhat over valued and place greater priority on the nominal exchange rate stability"); however recent rupee depreciation reflects the obvious: the exchange risk remains irrespective of monetary policy measures to control it.
Dar's heavy reliance on borrowing domestically and internationally and failing to implement reforms in the power and tax sectors are the root causes of the current economic impasse. Thus the inconclusive talks with the Fund with 555 million dollars September tranche release in the balance only partly reflects the impact of the dharnas.