Rs400bn bank advances to convert into investment

RECORDER REPORT

ISLAMABAD: Cornered by ever-spiralling inter-corporate debt in the power sector, the government would consider that the negotiations held with banks yielded a win-win result.

The government finally managed to strike a deal on sovereign notes with commercial banks; high cost quasi-fiscal lending. The banks were able to lock in relatively high interest rates for five years in Pakistan Investment Bonds (PIBs) and on lending for wheat procurement, at a time when the discount rate is expected to show a downward trend.

The banks also managed to increase their sectoral limit for the power sector, arguably winning more from the deal. Thanks to an accounting gimmick, banks have extra space to extend fresh credit to the IPPs.

In turn, the IPPs can use improved liquidity to increase their power supply to help arrest the rising shortage of electricity in the country.

Another extremely positive consequence of this arrangement is that no new liquidity has been created to feed the beast of piling debt in the power sector, because power sector loans of Rs300-310 billion including accruals (Rs16 billion) and commodity financing totalling Rs78 billion along with its accruals, will be converted to government paper worth Rs400 billion.

The plan chalked out at the Ministry of Finance (MoF), splits the aggregate of debt and accruals into two chunks of Rs 200 billion each. The first chunk comprising five-year PIBs, will be issued at an average rate of the previous two auctions. The 5-year PIB average rate for the mentioned period is 13.3 percent.

The second chunk of Rs 200 billion will comprise one-year T-bills at the rate of today's (Wednesday, October 5) auction. Market experts expect the one-year T-bill rates to average around 12.7 percent. This amount will be outside the auction calendar and will also be eligible for Statutory Liquidity Requirement (SLR), mandated upon banks by the State Bank of Pakistan.

The rates which the banks will thus secure are, consequently lower than what these financial institutions are currently earning on this debt. Two TFCs would, at today's Kibor, cost a little over 15 percent, while commodity financing is even higher by 50 basis points.

Still, the arrangement makes a financial sense for the banks because they will lock in an interest rate of 13.3 percent in relatively longer-term PIBs, as well as 12.7 percent on T-bills. In all likelihood, these T-bills will keep on rolling over; a welcome eventuality for these financial institutions at a time when SBP is expected to lower rates in successive monetary policy statements.

In fact, upcoming policy announcement from SBP is expected to slash the discount rate by at least 100 bps, and prove to be harbinger of lower rates to come.

Lastly and of course, most importantly, a cash-strapped and liquidity-starved power sector has been generating negative cash flows to the tune of Rs15-16 billion, beyond the circular debt amount. Finance ministry's effort will give the entire chain of the power sector much-needed respite, while the banks will also be better able to provide fresh funds to the IPPs and others.

Earlier attempts to convert the mounting inter-corporate debt into PIBs were thwarted due to the reluctance of one foreign bank. Had the banks agreed then, they would have ended up earning even better returns over a similar timeframe. However, this time around, it appears that the bank in question, as well as the others finally woke up and smelt the coffee.

Alas, the burden of corporate debt cannot vanish into thin air. In fact, the issuance of Rs400 billion in government paper will add a whopping addition of 2.2 percent to the fiscal deficit. The hefty load of debt will take the fiscal deficit galloping past the targeted 4.5 percent of GDP, for FY12.

Given that the government is no longer under the IMF programme, the government is unlikely to pass the buck forward to consumers in the form of power tariff rationalisation. This assertion is strengthened by historical precedence of governments avoiding non-populist measures in the run up to the general elections.