Averting default

The whole year Pakistan spent trying desperately to avert default and manage crippling shortages of foreign exchange.
Published January 2, 2023

It is hard to recall the last time when Pakistan mounted three abortive attempts to restart one IMF programme in a single year. This was the year it all fell apart — the “hybrid experiment” and the growth bubble it spawned, as well as the joyous triumph with which the PDM government swore itself into power. The whole year Pakistan spent trying desperately to avert default and manage crippling shortages of foreign exchange.

The year opened with the government of the time moving desperately to complete the sixth review of the IMF programme signed in July 2019. That programme was suspended in March 2020 with the arrival of Covid and the attendant lockdowns. Efforts to restart it began in November 2020 by Hafeez Shaikh in negotiations that were supposed to be completed by the following January, but which dragged on to March 2021.

Discussions with the Fund had ended in February and the staff report of the review was completed in March. Cabinet approval was required since two key conditions involved getting two key pieces of legislation approved and presented before parliament.

One of those was the much-debated bill to amend sections of the State Bank Act with an eye to granting the central bank greater autonomy. The cabinet approved these amendments and transmitted the bill to parliament in March 2021 without much debate and on the 24th of that month, the Executive Board of the IMF approved the release of Pakistan’s tranche of $500 million which arrived a few days later. Less than a week later Pakistan issued $2.5 billion in Eurobonds plus another $1.5bn borrowed from the World Bank. In one week immediately after board approval of the IMF review, Pakistan borrowed $4.4bn from global markets and international financial institutions.

That is when the present moment of troubles began.

No sooner had the funds arrived than the government reneged on the commitments made to the fund, Shaikh lost his election to the Senate and was removed from his position, and a few weeks later Shaukat Tarin was appointed in his place. Immediately upon arrival, Tarin made public comments about how stiff the IMF conditions were and expressed his disapproval of the proposed amendments to the SBP Act.

There followed a long nine months of wrangling in which Tarin tried to first argue that the proposed SBP amendments might require a constitutional amendment to approve, then argued that he can meet the revenue target of the fund programme by taxing retailers using “point of sale” machines and additional revenue measures need not be resorted to. By November 2021 all these measures were failing. The fund had told the government that the SBP Act amendments will have to be passed by parliament before the review could be completed and revisions in the revenue target will not be allowed.

In November 2021 came the first acknowledgement from the government that its strategy of trying to “renegotiate” the programme was not working and the pressures in the economy were mounting. Foreign exchange reserves began depleting in September 2021, falling relentlessly month after month ever since. The current account balance had remained briefly in surplus between May and November 2020, but plunged into a spiralling deficit from the next month, continuing relentlessly month after month ever since, draining the foreign exchange reserves.

The post-Covid bubble was bursting in full swing by the time 2021 ended. In November of that year, the State Bank announced an emergency monetary policy meeting in which it abandoned what it had called “forward guidance” all year and raised interest rates in a rush by 150 basis points. A couple of weeks later it raised them again by yet another 100 basis points. That November the government also requested another $3bn deposit from Saudi Arabia in a desperate attempt to shore up the foreign exchange reserves, and those funds arrived the next month in December. Then they moved in haste to abandon the effort to “renegotiate” the IMF programme and in a hasty cabinet meeting, approved the required amendments to the SBP Act.

But the reserves continued to fall at an accelerating pace. In June 2021 the deficit came in at $1.64bn, in November it touched $1.93bn, in December another $1.86bn. Dollars were flying out of the economy faster than they could be brought in.

This is how 2022 opened. In January the government passed the amendments to the SBP Act from both houses of parliament without a debate. As soon as the amendments were passed, the IMF staff forwarded Pakistan’s case to the Executive Board for consideration. But even before that meeting, the government went to the international capital markets with another $1bn Sukuk bond.

By this point the government had borrowed a cumulative of $5bn in two months alone, adding to the $4.4bn borrowed in March 2021. An emergency approach for borrowing from Saudi Arabia, an emergency meeting of the State Bank’s monetary policy committee followed by two rapid interest rate hikes, the hasty passage of the required legislation to unlock the IMF review, and the rushed flotation of a Eurobond even before the fund’s executive board had sat down to deliberate over Pakistan’s case were signs that there was growing desperation within the government to shore up the plummeting foreign exchange reserves.

By January 2022 foreign exchange shortages were driving emergency actions on the part of the government on a number of fronts. But when the IMF released its tranche of $1bn in February, the government once again reneged on its commitments and within weeks announced a massive subsidy on petrol and diesel, abandoned its plan to meet its failing year-end revenue target through taxes on these fuels, and went on to announce yet another amnesty scheme, something they had specifically committed in the fund programme that they will not do. Only a few days before this announcement the Russian invasion of Ukraine began and oil prices spiked in March, jumping from the already elevated $91 per barrel to touch $120.

The seventh review was scheduled for March 2022 but it floundered and never came to completion. In that same month, the government was also preoccupied with the impending vote of no confidence. The next month in April when the IMF team met with the newly appointed finance minister Miftah Ismail, they specifically pointed out that “[w]e agreed that prompt action is needed to reverse the unfunded subsidies which have slowed discussions for the 7th review.”

Here began one of the most gruelling adjustments that Pakistan has ever had to undertake. The IMF demanded not just a rollback of the “unfunded subsidies” but also a recuperation of the revenue losses suffered by the government as a result of rolling back on fuel taxes in February. It took the new government nearly two months to comply, undertaking the sharpest fuel price hikes ever done by any government in the past.

By June most of the targets committed to the fund had been missed. The budget announced by Ismail that month reflected the fund’s demands, but several questions remained unanswered. By now the commodity price spiral arising from the Ukraine war was in full swing.

It took Ismail nearly two months to convince his cabinet colleagues that the astronomical hikes in fuel prices being demanded by the fund were necessary, but in the end he succeeded. In May the “unfunded subsidies” started to be rolled back. On April 1, the price of one litre of gasoline was notified at Rs149. By July 1 this had climbed to Rs248, representing a historic 66pc increase in a matter of a few months only.

There followed an inflationary spiral, aggravated by a second oil price spike when global prices, that had come off their peak of $120 in March once again climbed to that level in June before easing somewhat. The new PDM government struggled with the rest of the conditions even as reserves continued to plummet to near-danger levels.

By June 2022 the first signs of a potential balance of payments crisis began to emerge. Import restrictions were being tightened to near-strangulation levels, cargoes began piling up in the ports, and banks were forced to borrow at a loss from forward markets in order to retire essential LCs for import of fuel. By July, talk of a default escalated. Holders of Pakistani bonds around the world began wondering whether they are better off selling their paper at a loss immediately rather than take the risk of a total collapse in their prices down the road. By middle of July, all eyes were focused on the ongoing parleys between Ismail and the IMF on completion of the seventh review.

Pakistan’s external financing requirements for the fiscal year had shot up to $33bn, despite a sharp contraction of the current account deficit projected under the fund programme. Debt service obligations were skyrocketing. Earlier in March rollover of a $2.5bn maturing deposit from China was held up due to the failure to complete the seventh review. That rollover was completed a short while later. In October another $6.3bn rollover was sought (with maturities a little later in the fiscal year). In November, the $3bn Saudi deposit received the previous year had to be rolled over and then in December, a maturing Eurobond worth $1bn had to be repaid. Along the way, another few billion dollars of debt taken from private banks had to be repaid as well.

The review was finally completed by end-August 2022 in a nail-biter finish that saw a last-minute attempt by the PTI to try and derail the talks by withdrawing, in writing, from a commitment to run a fiscal surplus in the province they controlled.

But then, no sooner had the review concluded, and the funds were disbursed, the country reneged on its commitments for the third time. Miftah Ismail was removed as finance minister and replaced with Ishaq Dar instead in a shock move that left the markets and the country’s creditors deeply concerned.

Dar brought old-fashioned ideas to the ministry. All through Ismail’s tenure he had tried to undermine the finance minister of his own party, by arguing that he is not doing a good enough job in negotiating with the IMF, that the conditions are too tough, that the fuel price and exchange rate adjustments are eroding his party’s political capital. Once in power, he sought to deliver on these words, saying in his opening remarks that currency stability is an important priority, announcing the rupee should be below the 200 mark to the dollar and trying to strong-arm the banks and the exporter community into fixing the exchange rate.

As the year closed, Pakistan had not defaulted on its external debt service obligations, but it was struggling to maintain its external trade with dollar shortages so severe the interbank market was largely shut down.

The year ended like it began. Severe dollar shortages, desperate attempts to get back onto an IMF programme, and a government struggling to halt the erosion of its political capital in the face of rising inflation. The faces changed but the situation remained the same, only more aggravated than it was at the start.

Published in Dawn Yearender, January 1, 2023

Header photo from Reuters.