Decoding Pakistan’s Circular Debt

Recent government estimates point towards the gas sector circular debt to have increased to PKR900 billion by end November 2022, compared to PKR719 billion as of March 2022. The companies affected by the debt include OGDC, PPL, SNGP, SSGC, and PSO.

The increasing quantum of circular debt in the gas sector has been detrimental to the energy security of the country in the recent past. Not only has it constricted the liquidity positions of the companies in the energy chain, but has also become a point of contention with the IMF.

The circular debt can be traced to: 1) diversion of costlier RLNG to Natural Gas consumers, 2) hike in UFG Losses, primarily theft, and 3) delayed gas tariff revisions.

Rising circular debt has put Pakistan in a vicious cycle. It has been widely documented that the increasing quantum has resulted in liquidity constraints, especially for the Exploration & Production companies, OGDC and PPL.

The stock of receivables on the companies’ books has increased from a collective PKR306 billion at the end of FY18 to PKR892 billion at the end of the September 2022 quarter.

With the mounting receivable burden on the companies, exploration activity has been subdued, leading to an inability to arrest the fall in production due to natural decline in reserves.

Gas production in the country has fallen from 3,997 MMCFD in FY18 to 3,390 MMCFD in FY22. This comes at a time when the demand for gas and energy is increasing.

This gap is being filled by imported RLNG, which is diverted to natural gas consumers and billed at lower rates, adding further to the stock of gas circular debt—putting the country in a vicious cycle.

Trade debt leads to lower exploration activity, ultimately leading to lower production levels, increasing the diversion of RLNG to natural gas consumers, which leads to lower cash collection, adding to the receivables, and the cycle continues.

Government is succumbing to the peculiar situation. Thanks to IMF’s impending ninth review, the government has finally taken notice of the situation in the gas sector and constituted a team to address the circular debt situation.

However, the agenda for the committee is short-term as it only aims to address the circular debt that has built up over the years, while not addressing the greater issue of policy measures required to arrest the buildup of the circular debt going forward.

The government would have to hike gas tariffs if it hopes to reduce the buildup going forward—a measure that has also been stressed by the IMF. Prime Minister Shehbaz Sharif has hinted towards the same in his recent address, paving the way for euphoria in the market.

From the vantage of E&P companies, specifically OGDC and PPL, any resolution of the receivables on the companies’ balance sheets would result in valuations being unlocked for the juggernauts.

If the government is able to overhaul the balance sheets of OGDC and PPL, it may lead to a re-rating in the multiples, unlocking upside potential.

Darnomics or Illusion

Without mincing words, allow me to say that Pakistan’s Finance Minister, Ishaq Dar, is busy in creating illusion that with his taking rein of finance an era of prosperity has begun. His premise that Rupee has got stronger against US dollar is nothing but gimmickry.

Let me remind my readers around the world that lately US dollar was made stronger artificially by the US administration. The US also wanted to create illusion that hike in energy prices around the world has failed in denting economy of the country.

One may recall that lately when OPEC Plus decided to curtail output, Joe Biden, President, United States was most furious. He knows that hike in motor gasoline is bringing down his popularity graph, which may led to defeat of his party in the mid-term elections.

Therefore, the attempts by Dar to show that Rupee is getting stronger are ‘misplaced’. In this endeavor, Pakistan is bound to lose more of its limited foreign exchange reserves.

This is also to remind him that in Pakistan there is a huge mismatch between the inflow and outflow of dollars. IMF tranche may have provided a breather, but the quantum of debt servicing is grossly unmanageable.

The brutal fact is that the recent floods have devastated country’s agriculture, displaced millions of people and their rehabilitation requires millions of dollars. If I am right bulk of the aid has come in kind and whatever paltry amounts have come is ’peanuts’ only.

This is to also remind the Minister that higher interest rate and persistent hike in electricity and gas tariffs are rendering Pakistani manufacturers, particularly exporters of textiles and clothing, uncompetitive in the global markets.

It is writing on the wall that imports will go up and exports will come down, widening the current account deficit. Since Dar has no control over imports, Pakistan’s only savior could be exporters. However, the lust to collect more PDL to bridge budget deficit is killing golden-egg layer, textiles and clothing industry.

Although, I am not an admirer of Miftah Ismail, any attempt to portray Dar as savior is like building an empire on the dead body of another person. If the readers are unable to understand this narrative let me say, “Miftah was used to announce all the bad decisions and Dar is being projected as a Savior”.

To conclude allow me to say, “The incumbent government has no clue whatsoever regarding pulling the country out of current economic crisis, all its policies can be termed ‘firefighting’ but the fire is too big and water is too little.”

    

 

  

 

 

 

 

 

 

Bangladesh Forex Crisis threatens macroeconomic stability of the country

According to The Bangladesh Chronicle, like other countries of the world, Bangladesh too is facing volatility in the foreign exchange market. This was initially caused by the demand recovery and supply chain disruptions as battered economies began recovering from the coronavirus pandemic.

The volatility has exacerbated in the last one month because of Russian invasion of Ukraine. This is not only likely to derail the rebound from the health crisis but also bringing about a bigger macroeconomic challenge for Bangladesh.

Maintaining a stable exchange rate of the taka against the US dollar is a populist idea that prevailed in the mindset of both the government and commoners. The same thinking might still be dominating, although the country seems to be facing a far bigger crisis than the pandemic.

Bangladesh Bank seems to be indecisive whether it would go for gradual depreciation of the local currency or opt for a quick devaluation. The situation has been created by the dwindling flow of foreign exchange.

Bangladesh Bank injected a record US$3.78 billion between July 1, 2021 and March 23, 2022 to stop the freefall of the taka, but the initiative has hardly resolved the crisis faced by the dollar-strapped banks.

Although, export earnings are on the rise, this has not been enough to offset the instability in the foreign exchange market led by a steep increase in import payments and a sharp decline in remittance.

Between July 2021 and January 2022, imports grew to US$46.67 billion, up 46%YoY. As against this exports increased 29% to US$27.97 billion. Remittance declined 19.4% to US$16.68 billion.

The imbalance between the inflow and outflow of US dollars has compelled many banks to purchase the greenback from Bangladesh Bank to settle letters of credit for imports.

The central bank is providing dollars to the banks with utmost generosity as the taka would face a major fall if the support is not extended.

The exchange rate now stands at Tk 86.20 per US dollar compared to Tk 84.80 a year ago. This means the central bank has allowed the taka to depreciate in a certain range.

But Ahsan H Mansur, an economist who earlier worked at the International Monetary Fund, describes the central bank’s move as insufficient to ensure macroeconomic stability from the current global turmoil.

“Bangladesh Bank will have to devalue the local currency by Tk 3 against the dollar immediately,” he said.

Higher imports against moderate exports brought down Bangladesh’s foreign exchange reserves to US$44.29 billion on March 23. This is way down from the US$48 billion recorded in August last year.

Economists think the worse is yet to come. This is because the impact of the global supply chain disruption stemming from Russia’s invasion of Ukraine has not fully hit Bangladesh yet.

Businesses usually open letters of credit two to three months before the arrival of imported products. So, the effect of the war will be visible a couple of months later.

 “The crisis in the foreign exchange regime will deepen if the increasing imports cannot be contained,” Mansur said.

He suggested bringing down the country’s import growth below 30% from 46% now or else the reserves will be hit hard by the ongoing instability.

The depreciation risks stoking inflationary pressure to some extent. The official figure of the Consumer Price Index surged to a 16-month high in Bangladesh in February driven by soaring costs of essential food ranging from staples such as rice, edible oil and vegetables to protein items.

“Inflation will increase, but you will have to embrace it for the time being,” said Mansur when asked how the government would tackle the situation.

“We don’t want to become Sri Lanka, which has long been facing a foreign exchange crisis,” he added.

Sri Lanka has been hit with the financial crisis because of a shortfall of foreign currencies. As a result, traders cannot finance imports.

On Tuesday, the country was forced to order troops to petrol stations as sporadic protests erupted among the thousands of motorists that queue up daily for scarce fuel.

“Any delays in taking initiatives to address the existing crisis will deal a fatal blow to the macroeconomic stability,” said Mansur.

Remittance flow through the official channel may reduce further as the exchange rate in the kerb market, an illegal trading spot, is higher than in the banking sector.

A foreign currency trader says that people now have to count Tk 91.80 per dollar, way higher than the Tk 86.20 interbank rate.

The foreign exchange regime volatility has even forced a bank to stop publishing US dollar rates in the last few days since the rates are fluctuating abnormally, said an executive of the lender requesting anonymity.

“If the kerb market continues to offer a higher rate, remitters will opt for the informal channel,” Mansur said.

“This will bring the reserves to a critically low level. So, the central bank should narrow the gap as the subsidy of 2.5% given by the government to beneficiaries of remittances is not adequate,” he added.

Md Habibur Rahman, Chief Economist of Bangladesh Bank, says the central bank has decided to gradually depreciate the local currency.

He thinks the exchange rate gap between formal and informal markets should be Tk 2.50 per dollar to ride out the ongoing situation.

If his view translates into reality, the exchange rate will have to be depreciated to at least Tk 89 per dollar, which is also supported by Mansur.

“The central bank will bring about quick depreciation of the taka to a certain degree since injecting dollars to keep the exchange rate stable is not an ideal stance for long,” Rahman said yesterday.

However, he has not given any hint as to how much depreciation will be allowed.

Another central bank official said the government would try to keep inflation in check in order to protect people from higher prices since the next general election is not far away.

Mustafizur Rahman, a distinguished fellow at the Centre for Policy Dialogue, says the reserves could cover import payments for more than nine months a few months ago, but now it can finance imports for about 5 and a half months.

He calls the gradual depreciation of the taka a time-befitting move.

“The depreciation will bring imported inflation. The government can lessen the woes of the common people by giving fiscal supports such as waiving or reducing taxes and value-added taxes, and providing subsidies to expand open market sales,” he said.

“But such fiscal measures will have an implication on drawing up the next budget,” Rahman added.

Syed Mahbubur Rahman, managing director of Mutual Trust Bank, says the imports of non-essential and luxury items have to be discouraged as some banks now face foreign currency shortages.

Brexit keeps Pakistan market under pressure

To begin with, it may be true that the local equity market remained under pressure due to Brexit, which was an overreaction. The decision by the public is yet to be approved by the British parliament. It will be a long drawn process but meantime the business will continue ‘as usual’.

The panic trickling down to Pakistan Stock Exchange plunged the benchmark PSX-100 index to 37,390 levels, down 3.58%WoW, after losing 1,412 points intraday. Regional markets also witnessed similar trend while crude oil tumbled, along with other commodities on a stronger dollar.

Barring Friday, lack of triggers kept market activity dull during the week where average daily volumes declined by more than 15%WoW to 155.7 million shares. Foreign participation remained under pressure, with foreigners selling equities worth US$20.6 million during the week against a net buy of US$19.58 million last week.

Key news flow impacting the market included: 1) National Assembly finalizing amendment in 2016 Finance Bill, 2) Current Account deficit for May’16 rising US$792 million as against a surplus of US$23 million a month ago, 3) the World Bank approving US$1.02 billion in developmental loans for Pakistan under the CGDPF and Sindh Resilience Project, while ADB approved US$100 million loan for the construction of Shorkot‐Khanewal section of the M4 motorway, 4) yields slipping by 3‐ 5bps in the latest Market Treasury Bills auction with the GoP raising Rs138 billion and 5) news source indicating rise in petroleum prices in the range of Rs1.75‐Rs4.5/ltr for July’16. Leaders at the bourse were: MTL, FATIMA, HMB, FCCL and AGTL; while laggards included: BAFL, MCB, AICL, NML and NCL. Volumes leaders were: KEL, DCL, PAEL and DFML.

Bouts of volatility are likely to be witnessed in the week ahead as investors react to uncertainty in the global outlook following ‘Brexit’. Negative implication for the bourse can also emanate from any extended downside in commodities, particularly crude oil. With volatility in major currencies, Autos on (JPY) and Textiles (on EUR and GBP) could see further downside.

After recording surplus for three consecutive months, current account balance returned to the red zone in May'16 recording a deficit of US$792 million expanding, consequently, 11MFY16 current account deficit to US$2.48 billion, up 1.2%YoY higher than the balance in 11MFY15, primarily reflecting a worsening trade deficit. The trade data depicts 22.6%YoY widening in the trade deficit in May'16 as rising imports (up 7.6%YoY) added to the burden of declining exports (down 6%YoY). With similar trends to continue analysts expect current account deficit to further deteriorate. Resulting pressures on current account and hefty debt repayment in FY17 can likely have spillover effects on the Pak rupee exchange parity. However, rising foreign exchange reserves and improving foreign investment outlook should keep erosion in rupee value limited.