The State Bank of Pakistan (SBP) has confirmed its commitment to a flexible and market-determined exchange rate, using interventions only for disorderly market conditions.
This has been noted in the "First Review under the Extended Arrangement under the Extended Fund Facility and Request for Modification of Performance Criteria" released here on Monday.
The Staff has stressed that the market-determined exchange rate remains crucial to avoid the reemergence of external imbalances and support the build-up of reserves.
The transition to a market-determined exchange rate has been orderly, allowing the rupee to find its new equilibrium quickly. After depreciating by about 15 percent in H2 FY 20191 to a peak of Rs/US$164 in late-June, the rupee has stabilized around Rs/US$155. Importantly, the State Bank of Pakistan (SBP) has abstained from foreign exchange sales since program approval.
Instead, taking advantage of favorable market conditions it has occasionally purchased foreign exchange from the inter-bank market, boosting its gross reserves by more than US$1.8 billion between July 1 and November 29. At the same time, the SBP has reduced its net short swap/forward Forex position by more than US$3 billion.
Staff and the SBP agreed that monetary policy stance is appropriate for now and should remain tight, until inflation shows a clear declining trend on a forward-looking basis.
Monetary policy under the program remains guided by SBP's medium-term inflation objective, supported by a positive policy rate in real terms, and the monetary aggregate targets that were met and should enable inflation to decline to the 5-7 percent range over the next two years.
Despite signs that inflation has started to stabilize, headline and core inflation remain high and are expected to decline only gradually keeping upcoming energy tariff adjustments and the pass-through from volatile international oil prices put upward pressure on inflation. The authorities committed to the monetary policy stance consistent with a policy interest rate that is positive in real terms.
Since program approval the SBP has not financed the budget deficit. Prior to program approval, SBP and the government re-profiled Rs 7,756 billion of short-term government debt held by SBP into tradable instruments carrying market interest rates in tenors of one, three, five, and ten years. Maturing debt held by the SBP will not be rolled over while the authorities will seek to amortize the existing long-term instruments to avoid financing pressures.
The report further noted that the SBP is preparing to submit amendments to the SBP Act, in consultation with IMF staff, to address all recommendations of the new 2019 Safeguards Assessment Report.
These amendments would, inter alia,: (i) establish domestic price stability as the SBP's primary objective; (ii) prohibit monetary financing of the public sector debt; (iii) remove of quasi-fiscal operations following a phase-out period; (iv) introduce statutory mechanisms for sufficient capitalization and profit retention; (v) secure stronger protection of the personal autonomy of senior officials; (vi) statutory underpinnings for external auditors, audit committee, and internal audit function; (vii) improve decision-making at the executive management; and (viii) provide stronger oversight by the Board.
In light of the wealth of changes recommended, the amendments to the SBP Act will be forwarded by the SBP to the Ministry of Finance by end-January 2020 and submitted to parliament by end-March 2020 (end-December 2019 SB; reset to end-March 2020 SB).
The authorities are actively engaged with the two private sector banks to develop plans to meet the minimum capital requirements by end-June 2020. They reported that one state-owned bank was liquidated in September, and another state-owned bank was included in the government's privatization list. Staff stressed the importance of addressing this long-standing issue promptly.
The authorities recognize the need to address weaknesses in the bank resolution and crisis management frameworks, including the deposit insurance scheme. They committed to strengthening and modernizing the resolution frameworks-supported by IMF technical assistance-and submit necessary legislation to Parliament by end-May.
The authorities have not introduced any new exchange restrictions, multiple currency practices, or import restrictions for balance of payments purposes and have not intensified any existing exchange measure (continuous PC).
The authorities are monitoring the balance of payments and remain committed to phasing out the existing exchange measures when conditions permit and to eliminate them by the end of the program. As a first step, the authorities allowed banks to make advance payments up to US$10,000 per invoice on behalf of manufacturing and industrial companies for the import of raw materials and spare parts beginning in early-November.
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