IMF review: power remains the key

The IMF second review is concluded. The staff-level agreement has not been reached; unlike in November review. That said, the tone was not negative. There might be some prior actions (such as increase in petroleum levy, increase in gas prices, pending fuel adjustment in power tariffs, increase in GST on goods where rates are low etc). It could be one or more of such actions that might be taken before the board meeting in third week of March.

In the second review, all the performance criteria were met with comfortable margins. There are issues in indicative targets (no waiver needed) and structural benchmarks (waivers might be required). This is not the first time that a staff-level agreement is not reached during a review. Having a waiver is not a big deal either. In the last programme under Dar, the Fund gave over a dozen waivers in twelve reviews. The media hype in the last few days is uncalled for.

Key is to look at economic conditions and wording of the statement. In external account, outperformance is much better than expectations. Net international reserve and forward/swap liability reduction are even better than Sep-20 targets. Reserves on SBP balance sheet are improved by $5.2 billion since Jul-19 and off-balance sheet (forward/swap) liabilities are reduced by $4 billion. The overall improvement is $9 billion. Out of which portfolio investment is $3 billion. A two-third of improvement is not hot.

There are issues on fiscal and energy fronts; but all binary targets are met in Dec-19 and are likely to be met in Mar-20 as well. There could be some give and take. Authorities outperformed in some areas and Fund may relax a bit on indicative target(s) and structural benchmark(s). The other way to look is that the statement's tone is positive and board rejecting a tranche in five weeks would be misplaced.

The IMF categorically said that real exchange rate is broadly in line with fundamentals. The second point is that inflation is on a declining trend. These two elements suggest that currency will not be under pressure and in a few months (Jul or Sep) monetary policy easing might start. There are some disagreements on fiscal; but IMF mentioned that fiscal performance remained strong in the first half.

This is not the worst case. Having said that, thorny issues are on FBR revenues and power tariffs. Government may or may not get away with these in this review. But these will surely haunt the authorities in reviews to come. At this point, any new tax could be counterproductive. It would be inflationary and could further slow down the economy. The government is losing political capital to do so.

One silver lining is declining oil prices in the aftermath of Coronavirus outbreak. Ministry of Finance probably has plans of increasing the Petroleum Levy (PL) by not passing on benefit of decline in oil prices to consumers. PL is not part of federal divisible pool and all the incremental revenue will go towards curbing fiscal deficit. However, this would not be enough. Expect new taxes by next budget. Plus, there are signs of economic recovery (LSM grew after many months in Dce-19). The import compression is bottoming out too. FBR revenues growth is dependent upon imports and LSM growth.

Most critical element is power sector tariffs. There is a structural benchmark for notification of Q2 FY20 electricity tariff adjustment for capacity payments. Government perhaps would want a waiver. Growing capacity payment on new power plants is jolting nascent economic recovery. The Finance Minister recently said on the floor of parliament that energy woes can be catastrophic. The PM, too, is vocal about it.

Time has come for government to start negotiating on lopsided IPPs contracts. The major portion of capacity is of debt repayment. For instance, coal power plant at Port Qasim under the CPEC is having PPA of 30 years but debt repayment is in first ten years. Out of $380 million annual capacity payment, $220 million is debt repayment. The story of RLNG plants is no different. There is a must run condition of 66 percent. This is linked to long-term agreement of must buy RLNG from Qatar, and price is fixed too (in terms of crude oil). RLNG spot prices nosedived, lately. These have to be renegotiated. India and other countries are in attempt to renegotiate its long-term buy deal from Qatar. Why can't Pakistan do it?

Pakistan has three options. One is to lower capacity payment through negotiations and work on improving discos governance. Second is to simply pass on the impact to consumers through tariff hike, as suggested by the IMF. Third is to ask for waivers (till IMF allows), and part away eventually. Second option is like killing domestic industrial competitiveness and swaying away consumers from grid - not sustainable. Take this out of equation. Third is not possible till reserves are built to a certain level. The FM hinted the SBP reserves target is $ 20 billion (right now it's at $ 12.4 billion). Prepaying the IMF (like Shaukat Aziz did) is not an option now. Invariably, the government has to bring IPPs on the table for negotiations.