In an intriguing development, the new IMF program has been thrusting upon the country a new financial regime without having any input from representative forums of the country. Mr Asad Umar, the first finance minister of the PTI-led government, had said in a session of the National Assembly that before signing the program, its detail would be placed before both houses of the Parliament. The program would be signed only after their inputs, he said. Like most of PTI’s promises, this too withered away in the air.
Questions were raised only after some strange policies began unfolding: there was an unprecedented rise in public debt in a single year, highest ever fiscal deficit, especially compared to budget estimates of a few weeks earlier, exceptionally high interest rates and sky-high inflation. Eventually, the picture emerged clearly about the nature of the conditionality the novice PTI government had accepted which was having far-reaching consequences on the functioning of Pakistan’s economy and the government’s ability to steer its course in periods of emergencies, such as the on-going Coronavirus pandemic.
The above developments will be analysed in detail in this article in order to assess how massively these would affect the macroeconomic framework and the grave consequences these would carry for the institutions of economic management without having any consultations with the public representatives of the country.
Debt Restructuring
The first dramatic development was a clandestine move to introduce a far-reaching condition that the government would no longer be allowed to borrow from the State Bank of Pakistan (SBP). Entire domestic borrowings of the government would be from primary dealers through quarterly and monthly auctions of government securities. The government was required to build cash-buffers in case of idle cash to be used in case the auctions were insufficient to meet maturing obligations.
This was followed by a massive restructuring of the outstanding government debt with SBP. This debt was always kept in six-month T-Bills. The restructuring, most surprisingly, converted this debt into long term PIBs of different maturities of three, five and 10 years. As a result, Long Term T-Bills amounted to Rs10,933 billion (67 percent) and Short Term PIBs Rs5,500 billion (33 percent) at end of FY19, as opposed to Rs3,413 billion (28 percent) and Rs 8,889 billion (72 percent) respectively at close of FY18, indicating sharp re-configuration of the long-term and the short-term numbers.
Evidently, of the Rs.7.6 trillion government debt owed to SBP at the close of June 2019, 71 percent or Rs 5.4 trillion was converted into 10-year floating PIBs at the then rate of 13.55 percent, Rs.1.6 trillion was converted into 5-year PIBs at fixed rate of 13.80 percent and the remainder into 3-year PIBs at fixed rate 14.25 percent. (It may be recalled that an “inverted yield curve” was prevailing at the time). Because of the floating-rate, bulk of the restructured debt in 10-year maturity would see declining cost as interest rates decline. However, interest on three and five year PIBs would remain fixed at high interest rates.
The following observations are crucial to understand the implications:
(1) The restructuring of the debt has led to an unnecessary increase in the cost of debt servicing by increasing the applicable interest rate;
(2) The average rate of TBs was around 10.75 percent just before the rate was increased by another 2.5 percent to 13.25 percent because of IMF program;
(3) It is claimed that this restructuring has been done to reduce or eliminate refinancing risk of short-term borrowing. This is not correct as the SBP debt faces no refinancing risk, because it would normally be picked up again by the SBP. Only the debt held by commercial banks and private sector would pose refinancing challenge;
(4) Accordingly, the reversal in the maturity structure is superficial. In 2014-16, the country witnessed a restructuring of debt in favour of long term based on reducing that debt which was held by non-SBP entities, including foreign lenders. A great deal of this was made possible by mobilization of foreign funding, mostly on concessional terms and some in the form of Euro Bonds and Sukuks. These were all long term, and significant room was created in money market by reducing government borrowings in the wake of foreign funding.
Cash Buffers Fund (CBF)
The second surprise move by policy makers was to accept the program condition under the Fund program that required zero-borrowing from the central bank. The condition stipulates that the stock of debt which was projected for June 30, 2019 at Rs7,756 billion would not only be frozen but further reduced to Rs7,187 billion by end-June 2020. However, the actual stock as on June 30, 2019 has come at Rs6,689 billion. Furthermore, as on March 13, 2020, there was an additional retirement of Rs1,172 billion reducing the stock to Rs5,517 billion. Accordingly, the IMF condition has been fulfilled with a long margin.
Despite this, we have voluntarily agreed to the harsh condition that going forward, irrespective of the existing debt stock owed to SBP, the government would not borrow from SBP. Simultaneously, the existing debt was converted into long term PIBs, as explained above.
To implement the zero-borrowing (prohibition) regime, a fund was created in the SBP, known as cash buffers fund (CBF), whereby Rs1,250 billion were borrowed from the commercial banks at around 14 percent and deposited in this fund. This CBF is now used to pick any slack in auctions compared to the maturities falling due. For instance, consider a T-Bills auction that has a target of Rs500 billion comprising Rs400 billion of maturities and Rs100 billion of new borrowing. Against this, if the bids come for Rs300 billion, then at least, to meet maturities, Rs100 billion would be required which would come from the CBF. The fund can be replenished when auctions are oversubscribed.
As on June 30 2018, government deposits with the banking system (including those held with SBP/CBF), were Rs1,929 billion, which rose sharply as on June 30, 2019 to Rs3,187 billion. This contained the Rs1,250 billion in the fund deposited on the same date June 30, 2019. At end-December 2019, this number increased to Rs3,742 billion, showing possibly even a higher CBF balance.
Apart from major challenges of cash management in a government that has seen many failed attempts to institute a Treasury Single Account (TSA), the initial cost of introducing the new regime is very high. While these funds are raised at a very high interest rate, the CBF balance doesn’t get paid any interest on such deposits as SBP is prohibited under law from paying any interest on cash balances maintained by the Government. More importantly, the debt management is now at the mercy of bankers who work in a collusive manner in lending to the government. What is even more alarming, according to a new report published on March 29, is that the SBP has forced Ministry of Finance to overrule Debt Office’s recommendation and to accept bids of banks at higher interest rates. Curiously, the SBP quietly ignored its own interest rate corridor and didn’t nudge the banks to make bids within its corridor.
Unfortunately, not having access to SBP borrowing would lead to such situations. This means that government would have no avenue to borrow, except to agree to the terms and conditions dictated by the commercial banks. Furthermore, much of the lending from these banks would be made possible because of deposits from government departments, for lack of a disciplined TSA regime and the funds provided by SBP to commercial banks through OMO.
Also, the government would risk that its cheques would be bounced by SBP, a key indicator of how economic sovereignty would be lost. It is simply breath-taking to reckon that government could agree to such a condition. Reportedly, the condition was resisted by the government until the new SBP Governor came on the scene who simply declared that this was in Pakistan’s interest and convinced the government to accept its inclusion in the conditions of IMF program.
Presently, the new financial regime has been voluntarily adopted without a legislative cover. However, in the name of furthering SBP autonomy, far reaching amendments in the SBP Act are also stipulated and agreed under the program and draft amendments were due to be moved to the Parliament by end-March 2020, which are likely to be delayed. If these amendments are approved by the Parliament, SBP would become the fourth branch of the state after executive, legislature and judiciary. The proposed amendments are:
(i) Establish domestic price stability as the SBP’s primary objective; (ii) prohibit monetary financing of the public sector debt; (iii) remove 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.
The proposed amendments would cripple the working of the government. It would transfer SBP effectively in the hands of the bankers. With a banking system that is acutely cartelized and in the hands of few families, this would mean few families would control SBP, the central bank of the country. It is unthinkable that a true democratic government would accept such wholesale compromise of its powers which are essential to regulate the economy.
Hot Money
Yet another horrendous step was the introduction of “Hot Money” in the country. To move in this direction, an even more deplorable action was to change the inflation target from “core inflation” to headline inflation just as there was a forecast of high inflation in the backdrop of extremely low inflation that prevailed during 2015-18 period. This allowed SBP to raise interest rate, which were significantly increased to 13.25 percent. All this was aimed at attracting foreign money in short-term government paper (primarily in three-month T-Bills), widely known as Hot Money. This initially led to a fast build-up of $3.5 billion in forex reserves through investments in T-Bills. On the other hand, SBP fortified its commitment to maintain high interest rate despite vociferous demands from business, industry and public that such a high rate was killing all.
Due to declining inflation, aggressive spread of Corona Virus, concerted responses of global central banks in reducing interest rates and widespread economic disruption, the Monetary Policy Committee (MPC) of SBP was in a tight corner and reluctantly agreed on March 17, 2020 to cut the interest rate by 75 bps. This was received with severe condemnation by forex/stock markets, business community as well as people. Consequently, a week later, an extraordinary meeting of MPC was convened which announced a further cut in interest rate of 150 bps taking the cumulative cut to 2.25 percent. The markets were still not impressed and the following day, despite a hefty assistance package for the economy, both stock and forex markets were rattled, a situation that continues to this day.
All through this period, the hot money has started departing. By now, out of $3.5 billion hot money that flowed in Pakistan since July 2019, $2.3 billion has already left the country. In the process, considerable pressure has built on the forex reserves and consequently on the exchange rate. Over the last month, the dollar has slipped from Rs154/$ to Rs169/$ and with SBP intervention it stabilised at 167/$. Taking devaluation of eight percent and interest rate reduction of 2.25 percent together, the effective return on T-Bills that was as high as 13.5 percent, has eroded and future hot money inflows would be minimal which may be a blessing in disguise.
The surprising choice made by policy makers to go for hot money by rejecting the long term Euro Bonds and Sukuks is at the root cause of unfolding crisis in the financial and capital markets. There is a very fundamental difference between the two approaches and ensuing implications.
The long-term loans are mobilised by the Government of Pakistan (GOP) and dollars are surrendered to SBP for building its forex reserves. Interest and principal payments are made as part of government external debt servicing, for which GOP is constantly engaged with all kinds of lenders. More importantly, the GOP mostly retires its domestic debt from the rupee cover from euro bonds/sukuks thus creating space for private sector to get more credit from the market. Furthermore, these sovereign papers are for 5-10 years and hence pose no challenge for refinancing in the short-run.
In the case of hot money, a foreign investor opens a Special Rupee Convertible Account (SCRA) and brings dollar to get local currency, which in turn is used to purchase short-term government securities. The GOP doesn’t feature in this equation because the surrendered dollars become the liability of the SBP and purchased government securities appear as no different than a local investor would have purchased. Curiously, in this process, the SBP has assumed the role of foreign currency supplier and putting it on its balance sheet. The risks of hot money departure are enormous and we have seen it. For no good reason we opened an unfamiliar channel of forex mobilization and then became its prisoner for keeping both interest rate and exchange rate favourable to hot money suppliers.
Government Approvals
Many watchers of the economy have expressed doubts whether necessary approvals for much of the “new financial regime” explained above were obtained. For instance, the approval for CBF was done in a single day on June 30, 2019, which could not afford completion of approval process of ECC/Cabinet. The approval of restructuring, which was a major departure from policy (of holding only short-term government securities) and setting of high interest rates thereon was also not obtained.
In another major development, the SBP had transferred more than Rs380 billion in profits credited to GOP at the end of third quarter of FY19 (March 31, 2019). In a remarkable manner, SBP reversed the transfer (by debiting the Foreign Consolidated Fund-FCF) taking the plea that considerable losses were incurred on revaluation of Saudi and UAE borrowings which were parked in the SBP. The final profit of SBP transferred to GOP for the whole FY19 was Rs12 billion only, which is one of lowest in decades. Whatever the justification, the summarily adjusted account, which entailed debiting FCF, has left serious questions of propriety and has challenged the competence of people in charge of economy.
During this period, media reports started emerging that all these decisions were taken by the Governor SBP through his influence over the Advisor Finance, who asked MoF officers to simply abide by governor’s views/wishes who is more knowledgeable than them. Also, the debt management function effectively slipped away from MoF to SBP and reporters routinely started using the phrase that “SBP decided to accept so much of the bids.”
Concluding Remarks
The PTI government, from the outset, has made continuing blunders in managing the economy. For one full year, it could not decide whether it would go for IMF program or not, while at the same time it kept depreciating currency and increasing interest rate. When finally it decided to go for IMF program, it was forced to further depreciate the currency and increase the interest rate. This acted like a combustible material for igniting the fire of inflation that soon shot up to highest in more than 12 years. Growth slumped, investments plummeted, industrial and agriculture productions nosedived and unemployment and poverty increased sharply. On the other hand, public debt rose from Rs24.2 trillion as on June 30, 2018 to Rs34 trillion as on December 31, 2019 and public debt and liabilities from Rs30 trillion as on June 30, 2018 to Rs41 trillion as on December 31, 2019, both of which reflect incredible increase in public debt and liabilities in a short period of 18 months of PTI government.
The above figures are mostly known and extensively debated. What was not known is the erection of a “new financial system” in a stealthily fashion which required to be brought to light through this article. The costs imposed on the economy could be gauged from the fact that PML-N government closed its last fiscal year June 2018 with an interest cost of Rs1500 billion. PTI had budgeted at Rs2932 billion for this year, but it has now been revised to Rs3300 billion. In two years, PTI government would be more than doubling the interest cost. This is all due to the new system: turning government debt to long term PIBs at much higher cost, sticking to high interest rate, pursuit of hot money and transfer of SBP’s resources to the whims of private bankers and seriously compromising government’s ability to conduct effective management of the economy and money supply.
Clarification: in Paragraph, 5 of the article, the words “PIBs” and “T-Bills” are to be interchanged and read accordingly.
The author is former finance minister of Pakistan and fellow member of the Institute of Chartered Accountants in England and Wales. He can be reached on Twitter: @MIshaqDar50