Pakistan Promises IMF to Raise Rates If Reserves Drop

By Michael Dwyer and Khalid Qayum

Dec. 3 (Bloomberg) -- Pakistan’s central bank promised the International Monetary Fund as part of a $7.6 billion bailout that it will increase interest rates further if the nation’s foreign reserves drop too low.

The State Bank of Pakistan said its benchmark rate “will be raised earlier” than the monetary policy statement due at the end of January 2009 if reserves fall below an agreed monthly floor, according to the loan arrangement between the IMF and Pakistan. The Washington-based lender posted the agreement on its Web site.

Pakistan, denying blame for last week’s terrorist attacks in Mumbai, was forced to turn to the IMF for a bailout after its foreign reserves shrunk 75 percent in a year to $3.45 billion. The IMF fell short of saying when it would allow restrictions on share trading to be removed, upsetting some investors who are awaiting the implementation of a 20 billion rupee ($255 million) government fund to help lift stocks.

“The stock market should be opened to allow free movement of capital,” said Farid Khan, director of equities at Credit Suisse Pakistan Ltd. in Karachi. “Focusing on the foreign- reserve position, while important, can damage the capital market and foreign investment.”

The Karachi Stock Exchange has prohibited investors from selling shares below their Aug. 27 closing prices, after the benchmark index fell 35 percent earlier this year. Ending the ban and “the use of public funds to support the stock market will be decided after reaching understandings with Fund staff,” the IMF said.

‘Tightening’ Policies

Pakistan’s economy may expand as little as 3 percent this fiscal year in response to a “tightening” of macroeconomic policies and a deceleration of growth in the nation’s trading partners, the IMF said. That would be the slowest pace since 2000, when South Asia’s second-largest economy grew 2 percent.

In order to secure the IMF loan, Pakistan’s government and central bank have also agreed to eliminate electricity subsidies by the end of June 2009 and to continue to adjust fuel prices to reflect international prices. That should reduce the budget deficit as a proportion of gross domestic product to 3.3 percent by 2009-10 from 4.2 percent in 2008-09 and 7.4 percent this year, the IMF said.

“Many of the major targets set by the IMF, including reducing the fiscal deficit and maintaining foreign reserves will bring discipline to the government,” said Samiullah Tariq, head of research at InvestCapital & Securities Ltd. in Karachi. “The IMF conditions aim at lifting the control of the government and the central bank over the fiscal targets.”

Interest Rates

The central bank’s net foreign-asset floor for the end of December, a breach of which would trigger the commitment to increase interest rates, has been set by the IMF at $1.165 billion. The level for March 2009 has been set at $671 million.

“Interest rate policy will be sufficiently flexible to protect the reserves position and bring down inflation,” the IMF said. “The program envisages a significant tightening of monetary policy.”

Governor Shamshad Akhtar on Nov. 12 raised the central bank’s key rate by 2 percentage points to 15 percent, describing the move as “the toughest decision of my life.” Inflation accelerated to near a 30-year high in October, with consumer prices soaring 25 percent from a year earlier.

The IMF has approved more than $40 billion of loans in recent weeks to prevent the global financial crisis and recession from undermining the stability of developing nations. Ukraine, Serbia and Iceland have already got funds from the IMF. Belarus has requested $2 billion and Turkey may also agree to emergency funding.

Pakistan completed its last IMF program in 2004 with a credit rating from Standard & Poor’s of B+, four levels below investment grade. S&P cut the nation’s rating to CCC on Nov. 14, one day before the latest IMF loan was announced, citing a risk of default on external debt payments.

To contact the reporters on this story: Michael Dwyer in Singapore at Mdwyer5@bloomberg.netKhalid Qayum in Islamabad at kqayum@bloomberg.net.