An unwarranted hit on financial sovereignty


By Mohammad Ishaq Dar

The direction of the State Bank of Pakistan (“the SBP”) to commercial banks (“the banks”) regarding the applicability of International Financial Reporting Standards (IFRS-9) in respect of loans, securities and guarantees of the Government of Pakistan has become operative with effect from January 1, 2022. Since IFRS-9’s initial issuance in 2019, an exemption till December 31, 2021 was given by the SBP to the banks regarding the enforcement of IFRS-9 on the aforesaid classes of sovereign assets. As the SBP has not extended the said exemption to the commercial banks, it essentially means that the Government of Pakistan can default on its Pak Rupee (domestic debt) obligations. In other words, the SBP has advised the banks to start taking into account the probability of default on sovereign loans taken by the Government and, resultantly, to make adequate provision in their financial statements for the potential loss on such sovereign lending. A belief that the Government cannot default on domestic debt has been virtually buried.

Pakistan history on sovereign obligations:

Since its inception in August 1947, Pakistan has never defaulted on any of its domestic debt/obligations. Furthermore, barring the 1971 separation of East Pakistan, when a small default occurred on Official Bilateral Debt, Pakistan has not ever defaulted on its “external debt”. With such a long history of performance, its curious as to why the SBP has chosen to require the banks to make provisions for holding Pak-rupee denominated credit and securities of the Federal Government.
It is incomprehensible to suggest that Government of Pakistan, a Sovereign State capable to print its currency, would ever fail to fulfill its Pak-rupee denominated debt servicing obligations. Therefore, it makes no sense to deprive government loans and securities from the status of “risk-free” sovereign financial assets.

The SBP has not given any rationale for the said change. The best explanation is the need to enforce IFRS-9. However, given that government loans and securities were exempted until December 31, 2021, there has to be some basis for withdrawal of such exemption. This is a serious matter and the SBP should have consulted the Government of Pakistan before taking such a far-reaching step.

The foremost implication of excluding the government loans and sovereign securities from the status of “risk-free financial assets” is the increase in the cost of borrowing for the government. Given that the banks have been asked to make provisions in their balance sheets relating to risk attached to such assets, their cost (interest/mark-up) of extending credits and investing in the government securities will automatically increase.

State Bank of Pakistan

The SBP aforementioned action would also have negative effect on the ability of the banks to extend unlimited amount of loans and credits to the government as was in practice before 1st January 2022. Regardless of the prevailing interest rates, the banks would not be able to buy the government debt beyond a threshold in the new scenario.
Consequently, it would be more expensive for the government to contract loans, issue bonds and sovereign paper. This will add further burden to already unsustainable debt-servicing and will also jack up the current high budget deficit.
Furthermore, the stature and ratings of the government credit and sovereign securities would take a hit. These financial assets may no longer attract creditors and investors in the same manner as was before this change.
The change is a clear signal to the financial markets that government’s domestic obligations carry the risk of default and therefore these financial assets would lose their attraction despite being sovereign.
This development will also have an impact on the pricing of our external borrowing as once country risk is established on domestic debt, it will have a natural bearing on the pricing of Pakistan’s foreign currency denominated sovereign debt. Recently Pakistan’s Sukuk has been priced at 7.95 percent, as opposed to US-benchmark interest rate of 1.73 percent, which is highest ever profit rate on a Sukuk floated by the Country.

It is intriguing that no reaction from Ministry of Finance has been seen on such a major change by the SBP in public policy. This appears to be a decision taken by the SBP in pursuance of the so-called “autonomy” granted by Imran-Khan-Cabinet through approval of an amendment Bill to the State Bank of Pakistan Act 1956 that has been widely debated in the country. The way PTI Government has bulldozed recently the said SBP Amendment Bill 2021 in the National Assembly and got it passed last Friday in the Senate of Pakistan in an unprofessional hurried manner speaks volumes as to how much PTI Government cares about the financial sovereignty of Pakistan.
The enforcement of IFRS-9 with effect from January 1, 2022 has also strangely coincided with the prohibition, through amendment in the SBP law, on the Federal Government from borrowing from its own Central Bank. Keeping in view the serious ongoing financial crisis faced by the government, the afore-discussed action of the SBP is nothing but a serious unwarranted hit on the financial sovereignty of Pakistan.

(The author, a UK Fellow Chartered Accountant, is former Finance Minister of Pakistan and former Leader of Opposition in the Senate of Pakistan. Twitter: @MIshaqDar50)