Sinking Deeper in Debt

Pakistan’s projected gross external financing requirement is estimated at $38 billion

Is Pakistan going to default in payment to its issued sovereign bonds? If not, yet, the declining foreign exchange reserves, disappointments from the friendly countries in financing Pakistan’s financial needs and delays in the international lending agencies in assisting the country are posing serious threats.

Sakib Sherani, a leading economist and former member of the prime minister’s Economic Advisory Council, said that the sovereign credit default swap had soared, while yields on the country’s sovereign Eurobonds spiked, reflecting the market’s view that Pakistan was in a very fragile situation.

“A critical question that has been keeping financial markets on the edge for months — especially since Sri Lanka slipped into default and economic meltdown earlier this year — is that if other emerging markets and developing economies (EMDEs) were also vulnerable to a similar situation,” he added.

“According to near-consensus market commentary between April and July, Pakistan was among the top five most vulnerable EMDEs, along with Ukraine, Egypt and Ghana,” he remarked.

For Sherani, the gross external financing requirement, based on the current account deficit, is estimated at $33 billion (7.9 per cent of the projected GDP). The estimated gross external financing requirement is without the need to build foreign exchange reserves.

Including a build-up of a minimum $5 billion in net international reserves in FY23, the financing requirement increases to $38 billion (9.1 per cent of the projected GDP), he said.

“I assume that Pakistan will receive around $3 billion in international assistance during FY23 for flood relief. This is likely to take the form of a debt relief, debt swaps and aid-in-kind, combined with enhanced multilateral assistance,” Sherani noted.

Steve Hanke, professor of Applied Economics at The Johns Hopkins University and a senior fellow at the Cato Institute, has recently alarmed Pakistan of debt default.

“Pakistan is on the brink of a debt default. Its sovereign bonds have lost more than 60 per cent of their value this year,” he said in a tweet.

“I am not surprised. Prime Minister [Shehbaz] Sharif’s government is failing to save the sinking ship,” he added.

However, the leaders of the ruling Pakistan Muslim League (PML-N) are giving statements in contrast to Hanke’s claim.

Finance Minister Ishaq Dar said that Pakistan would not default in any condition, as it would arrange finances to fulfil its obligations.

“There are sources, which I cannot explain right now. But it is certain the country will not fail to make payments,” he added.

The international bond market panicked after Prime Minister Shehbaz Sharif, during an interview to a foreign news agency, sought a debt relief from rich nations. This is on account of the losses the country faced due to the devastating floods and the signing of the International Monetary Fund (IMF) programme on tough conditions, including imposition of taxes on petroleum products and a raise in electricity tariff.

Umair Naseer, an analyst at the Topline Securities, said that Pakistan’s dollar bonds fell 12 per cent on the same day after the interview, whereas the dollar bonds maturing in 2024 and 2025 fell 15 per cent and 17 per cent, respectively.

“The yields on 2024 bonds have now increased to 60 per cent, whereas that on 2025 bonds are now up at 40 per cent,” he added.

Former finance minister Miftah Ismail has reportedly said that Pakistan will not default on debt obligations, despite catastrophic floods. In late September 2022, Ismail had said that the floods had affected 33 million Pakistanis, inflicted billions of dollars in damage and killed more than 1,500 people — creating concerns that the country will not meet its debts.

“The path to stability was narrow, given the challenging environment and it has become narrower.” But if we continue to make prudent decisions — and we will — then we are not going to default. Absolutely not,” he categorically declared.

After this statement and Dar’s return after attending the IMF and World Bank meetings empty handedly, the external sector of the country weakened further, especially the foreign exchange reserves, which significantly depleted.

The foreign exchange reserves of the country recorded a decline of $1.22 billion during the last one month. Similarly, the official forex reserves held by the State Bank of Pakistan (SBP) also fell $1.2 billion during the same period. The official foreign exchange reserves of the central bank trimmed to cover only six weeks of import payments.

Interestingly, the forex reserves also included the latest tranche of $1.2 billion from the IMF and another $2.3 billion from the Chinese bank.

Pakistan’s foreign exchange reserves declined $342 million to $13.247 billion by the week ended October 7, 2022, compared with $13.589 billion a week ago, i.e., September 30, 2022.

The country’s foreign exchange reserves hit the all-time high of $27.228 billion on August 27, 2021. Since then, the foreign exchange reserves have declined by $13.981 billion. The foreign exchange reserves of the central bank also declined $303 million to $7.597 billion by the week ended October 7, 2022, compared with $7.9 billion a week ago.

The foreign exchange reserves of the SBP witnessed a record high of $20.146 billion by the week ended August 27, 2021. Since then, these dropped by $12.549 billion.

The central bank admitted a decline in the external debt repayments, which included repayment of a commercial loan and interest payment on Eurobonds.

The government needs to pay $1 billion on bonds, maturing in December 2022. It has interest payments worth around $0.6 billion for the fiscal year 2022/23.

Jihad Azour, director of the Middle East and Central Asia Department of the IMF, in a statement said: “We accelerated some of our disbursements to the exogenous shocks and the food and commodities price hike. We had recently completed a review that provided Pakistan with $1.2 billion and hopefully we will be fielding a mission in November after the annual meetings in Pakistan to start talks with the authorities preparing for the next review.”

For Azour, the IMF was waiting for the assessment of the [flood] damages that the World Bank and the United Nations Development Programme (UNDP) are conducting to see the repercussions on the public finance and the impact on the economy and on the society.

The incumbent government was able to bring the IMF programme back on track after taking tough decisions, especially removal of subsidies, which resulted in a sharp increase in inflation. However, the positive sentiments after the release of $1.2 billion tranche was short-lived, as the country encountered massive floods.

The coalition government is making all-out efforts to avert debt default, Dar said, adding that he was endeavouring to persuade rescheduling of around $27 billion worth of non-Paris Club debt.

Dar also ruled out the possibility of a default on the country’s debt, an extension of the maturity date on bonds due in December or a renegotiation of the current IMF programme.

The multilateral development banks and international donors have been “quite flexible” with the ways to meet the country’s external financing needs estimated at around $32 billion after the devastating floods, he said.

In the meantime, International rating agency Moody’s Investors Service downgraded the Pakistan outlook to Caa1 from B3. The reasons were elevated social and political risks, which compounded the government’s difficulty in implementing reforms, including revenue-raising measures to improve the country’s fiscal position and alleviate liquidity stresses.

Pakistan faces the risks of a balance of payments crisis, which would increase if its external payments needs are higher than currently expected, for instance, because of the larger imports needs, while access to external financing is more restricted.

Moreover, while Moody’s assumes that access to official sector financing will be maintained and will be enough to meet Pakistan’s needs, lower financing and or higher needs would raise the risk of a default to a level no longer consistent with a Caa1 rating.

Moody’s said on September 25, the then finance minister indicated that Pakistan would seek debt relief from official creditors, on a bilateral basis.

“The negative outlook also captures the risks that should a debt restructuring be sought, it may extend to private sector creditors, despite assurances by the government late September that it is not seeking debt relief from the commercial banks or Eurobond holders. In this case, it would likely to constitute a default under Moody’s definition.”