By Asif Shahzad and Ariba Shahid

ISLAMABAD (Reuters) -Pakistan’s rupee touched a record low and its dollar bonds slumped on Thursday as the country struggles to unlock critical IMF funding, while a bigger-than-expected interest rate hike failed to revive its markets.

The rupee closed at a record low of 285.09, down 6.66% per U.S. dollar in the interbank market. The country’s international bonds fell by more than 3 cents on the dollar.

The currency – which has weakened by nearly 20% since the start of the year – has been sliding after delays in a deal between Pakistan and the International Monetary Fund (IMF) that parties have been negotiating since early last month.

“A delay in IMF funding is creating uncertainty in the currency market,” said Mohammed Sohail of Topline Securities, a Karachi-based brokerage house.

The IMF funding is critical for the South Asian economy, which has been in economic turmoil, to unlock other bilateral and multilateral external financing.

Pakistan’s central bank’s foreign exchange reserves have fallen to levels barely enough to cover three weeks of imports.

A move to a market-based currency exchange rate regime is among the actions the IMF wants Pakistan to complete to clear its ninth review.

If approved by its board, that would release a funding tranche of over $1 billion that has been delayed since late last year over a policy framework.

“Our negotiations with IMF are about to conclude and we expect to sign staff level agreement with IMF by next week,” said Finance Minister Ishaq Dar on Twitter – though his comments did little to reassure the markets.

PRIOR ACTIONS

The IMF’s prerequisites are aimed at ensuring Pakistan shrinks its fiscal deficit ahead of its annual budget around June.

Pakistan has already taken most of the other prior actions, which included hikes in fuel and energy tariffs, the withdrawal of subsidies in export and power sectors, and generating more revenues through new taxation in a supplementary budget.

The fiscal adjustments demanded by any deal, however, are likely to add to record-high inflation, which hit 31.5% year-on-year in February, analysts say.

To try to tackle soaring inflation, shore up its currency and fulfil another IMF demand, Pakistan’s central bank announced on Thursday a larger-than-expected 300 bps interest rate hike.

Bringing forward a meeting that had originally been scheduled for March 16, policymakers lifted the key lending rate to 20% – its highest level since October 1996.

Bilateral and multilateral external financing are among the other IMF demands, but progress has been slow.

Long-time ally China is the only country that has refinanced $700 million to Islamabad.

Speaking at a regular China foreign ministry media briefing on Thursday in Beijing, spokeswoman Mao Ning said China and Pakistan were “all-weather strategic partners and solid friends” and called on all creditors to “act together and play a constructive role in stabilising Pakistan’s economy and society.”

Pakistan’s international bonds suffered sharp declines.

Some issues shed more than 3 cents on the dollar and the premium demanded by investors to hold the bonds over safe-haven U.S. Treasuries rose sharply, with both at levels last seen in early January.

(Reporting by Asif Shahzad in Islamabad and Ariba Shahid in Karachi; additional reporting by Karin Strohecker in London and Yew Lun Tian in Beijing, Editing by Christopher Cushing, Kim Coghill, Barbara Lewis and Andrea Ricci)

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