ISLAMABAD (November 10 2008): Pakistan is expected to make a formal request for a Stand-By Arrangement with the International Monetary Fund, in this week to avoid default on its foreign currency obligations, it is reliably learnt. The Fund Board of Directors is expected to take up the request between November 12 and 17.

After weeks of protracted negotiations including e-mail exchanges, nine days of technical-level talks in Dubai and exchange of non-papers, an agreement on five contentious points has finally reportedly been reached.

They are:

-- A raise of 200bps or to 15 percent from the existing 13 percent in the State Bank of Pakistan discount rate prior to the disbursement of the first tranche with a firm commitment to increase it further in case inflation does not come down and imports are not curtailed. An overall 350 bps increase is said to be non-negotiable.

-- A 31 percent increase in utility charges would be undertaken as committed earlier to the World Bank for obtaining $500 million loan.

-- Fiscal deficit in FY09 to be reduced to 3.9 percent without loans from multilateral and bilateral sources. And, to 4.3 percent inclusive of loans from non-IMF sources.

-- Fund has condoned Rs 270 billion borrowed by the government from SBP between July and end October, 2008. However, any further borrowing of November to be reduced to zero.

-- No government bail-out of stock market from the Federal Budget directly or indirectly.

-- A critical review of the Fiscal Responsibility and Debt Limitation Act with an amendment with a view to limiting/restricting the Federal Government borrowing from SBP.

The reason behind Fund's flexibility on the SBP discount rate appears on grounds that oil prices have come down markedly and to provide time for the transmission mechanism of monetary tightening to work through the system. Fund wants to maintain the pressure to limit the volume of money creation in order to reduce the demand in the economy to replenish and build up forex reserves and also force the government to pay higher interest rate on debt.

While talks were under way in Dubai, the Cabinet announced a freeze on electricity tariff increase and ordered consumers to pay only 60 percent of the bills received for October consumption. This move reportedly did not go well with the Fund team involved in talks.

Second, the announcement to create a Rs 20 billion Opportunity Fund and Rs 30 billion put option package did not find favour as Fund officials felt it would create a moral hazard.

Third, the troubling aspect from the standpoint was the continuous borrowing by the government from SBP. The banks were not in favour of lending further to the government below the SBP discount rate. The T-Bills auction offers clearly reflected this strategy. Therefore, without raising the discount rate SBP was not able to mop up the full amount offered in the auction. As a result, the accepted amount was far less than the maturing T-Bills. Failure to roll over the maturing paper, SBP had to bridge the difference by lending from its own resources. This has resulted in creating more high-powered money.

According to Fund sources, the lenders want the present 'artificial structure' based on convenience to change. Otherwise, complacency will set in again in Islamabad once the overseas loans or aid, or both are received.

The way Pakistan has eaten up its forex reserves - as much as $12 billion in just over half a year - has been a serious source of all round criticism.

Copyright Business Recorder, 2008