Record Pakistan Reserves Mask Risks of Needing More IMF Aid

  • Debt, grants account for at least 50 percent of FX holdings
  • Lower oil prices cushion Pakistan; medium-term risks seen

Pakistan’s record foreign-exchange reserves are masking economic weaknesses that risk pushing the nation toward more aid from the International Monetary Fund.

At least half of the country’s $20 billion stockpile comprises debt and grants, almost all of which have flowed in since Prime Minister Nawaz Sharif took office in May 2013. That money could leave quickly as Pakistan begins repaying the IMF in 2016 or if oil prices surge, leading to another balance-of-payments crisis.

"This is borrowed money and not a reflection of a stable economy," said Yawar uz Zaman, vice president for research at Karachi-based Shajar Capital Pakistan Pvt. "Finance costs will continue to grow in the years to come, which will mean we will go for another loan from an international lender."

Sharif won a $6.6 billion loan from the IMF soon after taking charge, triggering a stock market rally that has put Pakistan among the world’s best performers. Since then, however, he’s struggled to attract more stable inflows as a shaky global economic recovery damps demand and makes investors wary.

The increase in reserves can’t be attributed to a single factor, central bank spokesman Abid Qamar said in an e-mailed response on Thursday. However, the holdings’ "robustness" can be gauged from the import cover, which has risen to "well above" three months from less than two in fiscal year 2013, and the reserves to external debt-servicing ratio has risen to 3.5 from 1.7, he said.

The record reserves will boost inflows along with recent investment agreements with China and Sharif’s focus on alleviating Pakistan’s energy crisis, Qamar said. He didn’t directly address a question on the odds of another bailout.

‘Low Quality’

Looming debt repayments in 2016 prompted Pakistan to go ahead with a $500 million overseas bond sale in September amid rising borrowing costs even as Turkey, Iraq and Abu Dhabi pulled back. It needs to gradually start paying back the IMF, with repayments rising to $639 million in 2019.

Foreign direct investment in the year through June 2015 was the lowest since 2012 with no signs of a pick up this year. Exports in September fell by the most since 2009 and domestic investors have boosted bank withdrawals by 38 percent from a year earlier.

"The reserves build up in the last two years is certainly of low quality," said Shamoon Tariq, Stockholm-based fund manager at Tundra Fonder AB, which holds $155 million of Pakistani shares. Low global oil prices should see Pakistan through the short term, but balance-of-payments risks will emerge in the months ahead if Sharif is unable to substitute dollar financing with investments, he said.

Investor Darling

Moody’s Investors Service in May cited the improvement in Pakistan’s reserves as an important sign that the threat of a debt default is receding, and raised Pakistan’s credit rating outlook to positive from stable. 

The nation’s dollar bonds due 2024 have returned about 20 percent since April 2014, while Bloomberg’s emerging-market sovereign dollar bond index has earned about 6 percent. Pakistani stocks have returned almost 50 percent under Sharif, the fifth-best performance among more than 90 indexes tracked by Bloomberg during that period.

Pakistan has become a "darling" among investors and "one of frontier’s favourite turnaround stories," Alan Cameron, a London-based economist at Exotix Partners LLP, wrote in a September report. Even so, he said, "looking beneath the surface, we see a few causes for concern."

IMF Call

Pakistan’s reserves are "sufficient" but not "healthy," and while there’s no need to seek another IMF loan the government will probably go for another three-year program, said Ashfaque Hasan Khan, a former adviser to the finance ministry and dean of the School of Social Sciences at the National University of Sciences and Technology in Islamabad.

The stockpile covers about five months of foreign-exchange payments -- more than the three the IMF considers adequate. Even so, Sharif needs to further boost holdings., the Washington-based lender said in an e-mailed response on Friday.

"International financial markets have been volatile, the balance of payments position remains vulnerable, and reserves are still significantly below adequacy norms," IMF staff wrote in a report this month. "Pakistan has the capacity to repay the Fund, but the materialization of risks to the economic outlook could erode it."

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