Moving the goalpost: An 'Innovative' Payment Structure
Abdul Hafeez Shaikh, PhD economist ex-IMF, is playing accounting tricks to meet IMF benchmarks
UPDATED: I had not understood it completely earlier. After having discussed with someone knowledgeable, I have updated it to include the income statement effect.
The newspapers report that the Government of Pakistan (GoP) has reached a settlement with IPPs. GoP will make payment to IPPs in three instalments over a period of one year. Each instalment will be composed of one-third cash and two-thirds floating rate 10-year PIBs. The PIBs will be priced at 6month Marketable Treasury Bills (6M MTB) + 0.70%. As per Abdul Hafeez Shaikh(AHS), this [2/3rd of each instalment comprising of PIBs] was the mechanism that was most feasible to the GoP due to fiscal constraints imposed upon them as part of the IMF’s program. I am trying to understand how can this arrangement help GoP to remain within IMF conditions.
The overdue receivables of all IPPs stand at Rs.700 billion. At the end of October 2020, overdue receivables of 47 IPPs that signed the MoUs with the government stood at Rs.451 billion. GoP proposed that payment to 47 IPPs be made as per the aforementioned arrangement in settlement of their receivables. The first instalment will be made in January 2021. The second instalment will be paid in June 2021. The final instalment will be paid in December 2021.
The Rs.300 billion question
Balance Sheet Perspective
From a hypothetical balance sheet (BS) perspective, the justification provided by AHS for adopting this mechanism doesn’t make sense.
Typically, unless GoP is flush with cash, GoP makes the cash payments after raising money through an auction of Government securities: SBP auctions T-Bills/PIBs on behalf of GoP. Primary dealers (PD) participate in the auction and purchase the securities. SBP debits the account/reserves of PD maintained with SBP and credits GoP account maintained with SBP. Finally, GoP can make the payment to IPPs from this account, which is being referred to as cash. In GoP accounts, this appears as PIBs in GoP Debt section as shown below.
Alternatively, if instead of raising cash, GoP hands over 10-year floating PIBs to IPPs, PIBs will still appear in the same place. GoP has skipped the step of raising cash from the market i.e., GoP is settling the IPP payables in-kind.
Whether GoP pays in cash (after auctioning PIBs) or settles the debt in PIBs, the debt position of GoP remains the same.
Income Statement Perspective
From hypothetical Income Statement (IS) ie fiscal budget perspective it is an accounting trick. If PIBs were auctioned and actual cash paid, the payment would have been reflected in the budget expense side thus increasing the budget deficit. IMF has presumably set a ceiling for the deficit. Thus by skipping a step of auctioning PIBs, we are avoiding recognizing the expense in the budget, an accounting gimmick at best.
I love how it all boils down to accounting tricks with finance ministers whether they are chartered accountants or an IMF pedigreed economists.
Pricing of PIBs
If the PIB coupon is referenced against 6M MTBs, it is safe to assume these PIBs pay profit semi-annually. As per SBP's Domestic Market & Monetary Management Department (DMMD) circular no. 23 dated Oct 16, 2020,
For Semi-Annual paying bonds:
3(a). The coupon rate shall be equal to the weighted average yield of the 6-month Market Treasury Bills (MTBs) as determined in the latest successful 6-month MTB auction held prior to the floating rate PIB’s auction and/or the start of the coupon period.
3(b). In case, the latest held auction of 6-month MTBs is either rejected or there is no participation from the market, the average of 6-month (i.e. 121- 180 days) PKRV applicable for last five working days prior to the PFL auction or before the start of the coupon period will be used as an alternate coupon rate.
3(c). The coupon shall be paid and reset semi-annually, according to the procedure explained above.
Separate instructions will be issued for coupon determination, payment and resetting of monthly coupon paying bonds when the Finance Division decides to issue such bonds.
Back to square one
As per one news item, IPPs are rejecting the GoP proposal. I haven’t looked at the financials of IPPs and it may be that IPPs need immediate cash to settle their liabilities i.e. interest payments, principal repayments, or dividend payouts. To meet the obligations, IPPs will have to sell these PIBs into the market right away and will most likely sell to the very banks/primary dealers from whom GoP was supposed to raise funds by auctioning PIBs.
Alternatively, IPPs can ask banks to accept the PIBs in lieu of interest/principal payment.
Both of the above steps bring us to the same position i.e. PIBs are making their way to the very PDs from whom GoP could have raised cash if it had auctioned PIBs.
Thus, for an accounting trick, GoP is forcing IPPs to take extra steps to achieve liquidity.
Why else would GoP be avoiding the auction of PIBs?
As per BR Research, in the 18 months of Jul 19 to Dec 20, in 26 auctions, GoP sold an average of Rs.36 billion of 10-year floater PIBs. The share of PIBs in the first instalment of IPP payment translates into a volume of Rs.89 billion, which is 2.5 times the average auction issuance. BR Research notes this will "add to liquidity" in the market. IPPs and banks may deem it flooding the market. When markets are flooded, the price decreases. Probably this is the reason IPPs dislike this arrangement.
Making it work
GoP and Finance Division, it appears, are sold on this structure. BR Research adds three ways to make it work.
GoP is considering shelving two [10-year floater PIB] auctions in the next 6 months (to average out the supply as the first instalment is 2.5x times the average auction). Will GoP commit to this in writing or should IPPs take GoP at face value?
It doesn’t make sense for GoP to forego raising cash (by cancelling auctions) just to keep the price of PIBs from falling. Might as well pay the IPPs in 9 instalments aligned with auction dates and pay the IPPs in cash each time.
Another option "coined by IPPs" is to give these bonds against payables to PSO, SNGPL, OGDC who can use these PIBs in their pension funds. The whole sector is facing a liquidity crunch. If PSO, SNGPL etc want PIBs for their pension funds, the pension funds can directly buy it in the primary or secondary market. But if PSO, SNGPL, OGDC require the payments to meet their onward obligations, they also need cash. The IPPs have passed on their Hot Potato to these entities.
Besides, this will require bringing in more entities in the MoU i.e. getting PSO, SNGPL, OGDC etc to agree to this arrangement before the deal is finalized.
Profit payment on PIBs is taxable at 30%. If IPPs borrow from banks against these PIBs, the interest on the loan can't be expensed for tax purposes. IPPs are in talks with FBR to exempt the coupons from tax as it will resolve this issue i.e. coupon from PIB will offset the interest on the loan.
The third one seems the easiest option for now. If there are other implications of this, I do not know.
Two out of three proposals to make it work don’t appear workable. But if this really is the preferred way to bypass IMF restrictions and GoP, by some miracle, is successful in getting IPPs to accept this, it may open floodgates for GoP to settle its other liabilities by issuing PIBs too. Unless IMF comes back and shuts down this loophole by including it in the fiscal constraints in its next review.
Bottom line
If GoP is trying to shift the market risk of PIBs to IPPs i.e. risk that market price of PIBs will decrease due to oversupply of PIBs, IPPs too can see through this charade and may not agree to it.
I am flummoxed why is this accounting trick mechanism is being suggested as the debt position of GoP remains the same. Will IMF not see through this gimmick? I don’t buy Abdul Hafeez Shaikh’s justification. His track record does not give me confidence.
It is hard to get the correct information from the newspapers. Express Tribune on Jan 2 implied that the proposal was from the government. The Profit, on the same day, reported that it was the IPPs that asked for payments to be made in PIBs. Dawn reports on Jan 5 IPPs have rejected the government proposal and have demanded that 50% of payment should be made immediately in cash and the balance could be 30% in June and 20% later in a combination of cash and bonds. And BR Research reports on the same day that the deal proposed by the government is an (almost) done deal and IPPs are negotiating with FBR with how to deal with tax issues.
Instead of leaking/releasing information to newspapers, it will be better if the GoP releases the MoUs and Discussion Papers on its website so that we can at least know the government's viewpoint correctly. Then we can read the other party's viewpoint in the newspapers.
Before I forget, Kamran Khan had tweeted on Jan 1 that General Bajwa was involved in getting the deal closed.
