Dec 22 - 28, 2008

International Monetary Fund (IMF) has finally made public the harsh conditions, which have been agreed upon by the Pakistan government in order to secure $7.6 billion loan from the Washington-based fund. The demands attached with IMF loan will cost dearly to the people of Pakistan. Under the deal, the government is bound to raise interest rates to control inflation in case central bank's foreign reserves fall below monthly floors set by the IMF. The government would have to withdraw the subsidy on electricity by June 2009 and bring its borrowing from the central bank to zero during the current fiscal year. The economic growth has been set at 5 percent, while inflation at 13 percent for the next fiscal year. The Fund has also restricted the country from lifting the price floor or providing any financial support to its main stock market, without its prior approval.

Analysts believe that the IMF conditions would lift the control of the government and the central bank over the fiscal targets. The IMF has posted the loan agreement with Islamabad on its website. The deal envisages a significant tightening of monetary policy, as central bank has agreed to further increase interest rates in case the country's foreign currency reserves witness a fall below an agreed monthly floor. The central bank has already raised its key rate by 2 percentage points to 15 percent last month prior to the approval of rescue package from the IMF.

The central bank's net foreign-asset floor for the end of December has been set by the IMF at $1.165 billion, according to the loan agreement. The level for March 2009 has been set at $671 million. According to the central bank, the country's foreign currency reserves stood at $9.4 billion on November 26, compared to $6.6 billion as of November 22, reflecting the arrival of the $3.1 billion from the IMF.

According to the loan agreement, the fiscal deficit is targeted to decline to 4.2 per cent of gross domestic product in the current fiscal year, from 7.4 per cent the previous year, by increasing tax revenue and the elimination of oil and electricity subsidies. The country would have to raise its national growth rate to 7 percent and bring down the inflation rate to 5 percent by 2012, while the target of keeping the foreign current account deficit restricted to $10.6 billion i.e. 6.5 percent of the GDP by the end of the current fiscal year.

State bank of Pakistan will eliminate the exchange restriction on advance import payments against letters of credit will be eliminated by end-January 2010, subject to a marked improvement in the balance of payments position. No intensification of existing restrictions and no new exchange restrictions or multiple currency practices will be introduced during the program period. The SBP will prepare a contingency plan to deal with problem private banks by end-December 2008. The plan will contain criteria for SBP liquidity support, assessment of bank problems, and intervention procedures.

Under the agreement, the central bank is committed to pursuing a flexible exchange rate policy under which it will not provide foreign exchange for the imports of oil products to make foreign reserves intact.

The government is in agreement with the Fund to further increase tariff to waive electricity tariff differential subsidies by end of on going fiscal year. For the current fiscal, the government has fixed tariff differential subsidy of Rs77 billion. The government has committed to extend zero subsidies in power sector in the next fiscal.

The implementation of the electricity tariff increases will be followed up in the context of the program reviews.

Fund's other conditions include interest rate raise from 3.51 to 4.51 percent; taxation reforms; transparent social safety net (SSN); elimination of inter-corporate circular debt; increase in tax-to-GDP ratio to 15 percent in 5-7 years; single treasury account; programming of treasury bills auction; flexible exchange rate with transfer of oil import bill to interbank market; contingency plan for problem banks; enhancement of central bank's autonomy with powers of enforcement; and consultations with the Fund before lifting stock exchange 'floor' or providing any financial support to it.

The IMF has rejected the proposal for a support fund for Pakistan stock market, which has remained hostage to government's decision regarding lifting of price floor for more than three months. The proposal for removal of price floor was recently sent to the Fund for approval. Under the proposal, the price floor will be lifted from the benchmark Karachi stock exchange (KSE) 100 index, with 2 percent lower circuit, from December 12, as Rs 14.5 billion has been made available for market stabilization fund. The floor was imposed in August to protect share prices, but the market could not return to normal trading parameters due to Pakistan's deteriorating economic fundamentals and worsening law and order situation. Analysts believe that the stock market deadlock may only ease if fresh funds could be injected not only into the stock market but the whole financial system.

"Given the weak external position, it is important that the removal of the current floor on stock prices take place only after the macroeconomic situation has stabilized and investor confidence has improved. In addition, the authorities should avoid using public funds to support stock prices," according to IMF website.

Karachi Stock Exchange (KSE)-100-share index lost 4 percent or 370 points closing at 8,817 points on December 15 when floor was lifted. The flooring had halted the market and the investors have lost interest at KSE, as the government has so far failed to activate its earlier proposed Rs20 billion market-support fund. Floor freeze continued to dampen market sentiment, with investors remained pre-occupied in discussions for support measures and removal of the artificial floor. The KSE100 share index has witnessed a fall of nearly 35 percent this year. The market players anticipate massive requirement of dollars in the next few weeks, as the foreign investors would withdraw their money from the stock markets after removal of floor.

The benchmark KSE-100 share index remained hostage to government's decision regarding lifting of price floor for more than three months, as the government could not bring into operation the market support fund and other instruments like 'put option', which could provide a soft landing to the market after removal of price floor. The IMF had restricted the government from using public money to bailout the cash-starved KSE-100 share index. Securities and Exchange Commission of Pakistan (SECP) the apex regulator had to announce lifting of floor from all three stock exchanges of the country to from December 15 without any market support fund.