An important question is why SBP talking interest rates too high - especially the last hike of 100 bps - after getting the first tranche from the IMF. The prior conditions of the Fund were already met, which means that there is more to the recent increase in interest rates. It’s not inflation, as it does not make sense to curb inflation by keeping around 600 bps real interest rates. There has to be more in the mind of IMF and SBP Governor to further stress the already slowing down economy.

Reading between the lines, the inflationary concerns and low growth implications are secondary in consideration. The prime focus is to build up the foreign reserves and thus increase NFA part of the money. Within domestic economy, the focus could be on documenting informal economy by a combination of carrot and stick. The system liquidity is limited, and interest rate hike has limited bearing on it; and within existing banking system money, there Is no way to finance fiscal deficit, but by bringing directly or indirectly SBP lending into the equation. For details read “OMG! Look at those OMOs” published earlier this week.

The strategy of keeping high interest rates is tricky, because if the desired outcome of foreign investment and domestic money out of the system does not materialise, the high debt servicing cost could be detrimental. The higher rates have almost doubled the debt servicing cost in the past two years, and to keep the deficit at manageable levels, too ambitious FBR revenue targets are set.

The slowing down of economy is making the 40-percent-plus FBR revenue growth target even more challenging. And if the NFA is not built, the economy could further go into abyss. The core focus is probably to attract hot money in government papers. That had happened in Egypt; and architect of that policy is now at the helm in SBP.

According to market sources, Raza Baqir is keen on foreign institutions to buy PIBs and T-Bill as he deems that the carry spread is attractive enough to take the currency risk. The idea is to lure hedge funds to take position in Pakistan’s fixed income papers – the borrowing cost in USD for these funds is around 2 percent and the market rates are offering around 14 percent in PKR. That gives a cushion of 12 percent currency depreciation to breakeven on pre-tax returns. The forward cover is offering at 8 percent or less, which implies a pre-tax arbitrage of 4 percent

The capital market participants are urged by the central bank to market Pakistan papers to foreign funds. There are some taxation glitches, which the government is committing to resolve soon. The laws are formed for Pakistani investors where WHT tax is deducted at face value at the time of investment and income tax on realising gains, if the bond is sold prior to maturity.

The foreign investors have some reservations on taxation system, which has to be resolved through offering money bill (a mini budget). Expect the money bill to come in a few weeks’ times, and once that is done, a push on bringing foreign portfolio investment in debt by capital market players will be exerted. Government has budgeted Rs1.9 trillion debt servicing from foreign sources this year, and that is to come from these funds or through Euro bonds/Sukuk. And even higher number could be realised, if things go smoothly.

There are some risks as never in the history of the country has such big sums of foreign money poured in government papers. And the taxation handling with care is of utmost importance too. Apart from that, CIC has to be curbed by luring that amount in the system. And the money that is laundered every year outside Pakistan has to stop as the investment at home becomes more attractive. All these look good on paper; but reality in Pakistan could be different. Keep fingers crossed.