The odds of Pakistan’s default on its borrowing are increasing. The country’s risk of default, measured by the 5-year credit default swap (CDS), touched 52.8% recently, a 13-year high, indicating that foreign investors are losing faith in Islamabad’s ability to honour its repayment obligations. The CDS hovered around 5% to 6% before the Covid-19 outbreak in February 2020. It is being increasingly clear that expectations in the Pak economy is not picking up despite the IMF programme of revival and release of USD 1.27 billion tranche. It could be the result of profligacy and wrong priorities of the Pak government over a period which eventually led to deep rooted structural distortions. Rather than addressing these issues, the Pak leaders are presently engaged in an unending political brawl which leaves little scope for economic reforms.
Fast deteriorating CDS is signaling the foreign investors that Islamabad is precariously near default. Rather than taking SOS measures for economic revival, Islamabad is still pinning its hope on assistance from Saudi Arabia and China which have dried up in recent past. The state exchequer is empty as evidenced by low level of foreign exchange reserves and weak revenue due to sluggish economic activities. Earlier in the middle of the year, the CDS hit a peak of around 30% when there was uncertainty over the revival of the IMF loan programme. With very high CDS, the question arises whether Islamabad would be able to repay its maturing debt in immediate term.
The foreign investors have been panicked amid forex reserves depleting by around USD 9 billion in the last 10 months in spite of Finance Minister Ishaq Dar and his predecessor Mifth Ismail assuring time and again that Islamabad would easily meet its international payment obligations but the global lenders are not convinced. The next major payment obligation due is a USD 1 billion 5 year Sukuk bonds maturing on December 5. Forex reserves have now dropped to a critically low level of 1.1 month import cover at USD 7.6 billion from USD 20 billion in August 2021 which was sufficient for three-month imports. This raises the concern about imminent default.
The yield on the 5-year Third Pakistan International Sukuk touched new high around 145% against below 10% before the Covid-19 pandemic. Meanwhile, yield on bonds maturing in 2024 and 2025 also rose to 90% and 57.5%, respectively, indicating amiss in financial management of the country. These are disturbing developments because it would make new borrowings for Pak to service its past debts costlier. This indicates making of a debt trap.
Ismail Iqbal Securities Research Head Fahad Rauf said that “foreign investors have panicked following the global rating agencies Moody’s and Fitch downgrading Pakistan’s credit rating in the recent weeks.” The catastrophic floods have multiplied the external financial crisis as it was already facing an economic slowdown amid the government’s measures to cool down the overheated economy.
Islamabad’s efforts in getting out of Paris based FATF’s ‘grey list’, literally had no impact on foreign investors as credit rating agencies had already downgraded credit ratings. The recent being Fitch Ratings downgrading Pakistan’s long-term foreign currency issuer default rating (IDR) to ‘CCC+’ from ‘B’-, coincidentally with the ADB approving financing of USD 1.5 billion and the FATF upgrading from the grey list. The rating agencies have pointed out towards deep rooted structural problems and urgency for economic reforms.
Further, the downgrading also reflects increased risks of policies potentially undermining Pak’s IMF programme, a major cause of concern for lenders.
The country’s leadership is still in search of global lenders to arrange USD 36 – 40 billion for the current fiscal year to repay foreign debt of USD 21 billion and to cover current account deficit of USD 10-12 billion by the end of June 2023.
Arif Habib Ltd. Research Head Tahir Abbas said the size of Pakistan’s global bond market had reduced considerably these days. He observed “CDS also faces the same dilemma of low investors’ base.” Increasing political instability in the country is the reason behind the panic among the global investors in Pakistani bonds.
Earlier, a report of the Finance Ministry found that external debt sustainability indicators worsened last year due to country’s increasing reliance on short-term foreign loans, government’s exposure to risks related to refinancing and depreciation of rupee. It was sort of accepting government’s shortcomings. But what purpose does it serve if ameliorative measures are not taken up in right earnest and quickly? Now analysts are wondering could Pakistan go Sri Lanka’s way.
Depreciation of rupee is another impacting factor that is worsening Pak’s repayment ability as it increases the value of debt stock. According to Finance Minister Ishaq Dar, the total public debt jumped from Rs39.9 trillion to Rs49.2 trillion within a year, an unsustainable increase of Rs9.3 trillion within a year. The Rs3.8 trillion worth of increase was due to currency depreciation as the exchange rate slipped from Rs157.3 to a dollar in June 2021 to Rs204.4 in June 2022. The rest of the increase was due to budget financing needs.
In the times when expectation in the Pak economy is at its lowest and continues to be so far quite some time, Foreign Direct Investment plummeted by 47.1% to USD 253.4 million in the first quarter of the current fiscal year, driven by weak inflows especially from China, UK and USA.
There is no hope for Pakistan except some help from its development partners. Islamabad is hopeful to receive a rollover debt worth USD 6.3 billion commercial loan and USD 5.2 billion bilateral debt mainly from China and Middle Eastern banks and financial institutions. It needs to convert their short-term loans and liabilities into long-term ones. It is up to the leadership to convince them including China to roll over to save the country from economic crisis. Had global conditions not been bad, issuance of new bonds could have given some relief to Islamabad. However, continued deterioration in country’s macro-economic fundamentals have added to uncertainty. Things are fast worsening and time is running out. Pakistan needs to change its focus from political bickering to economic reforms.