Default of External Liabilities: Why Pakistan Default will not happen in 2022 or 2023

                                                                                                                By:     Irfan Karim

Background 

Financial circles have remained rife with speculations that Pakistan Default seems imminent in 2022. Some link it to Sovereign  Bonds maturity due on December 05, 2022.  Others base their view on depleting foreign exchange reserves. Sri Lanka default is also cited as an example amidst post-Covid financial slow down that  has adversely hit the vulnerable economies of certain developing countries.

Market sentiments on probability of default by Pakistan were also aggravated  after Rating downgrade of Pakistan’s external debt by Moody's and Finch

Here we take a stock of all the factors to understand how Pakistan continues to exercise resilience and how Pakistan Default in not happening.

 

Default Rumors and the Sri Lanka Default of External loans

 

Foreign exchange reserves of Pakistan came down over the last few quarters, mainly due to lessor remittances and outflow on account of of debt servicing. Pakistan relies heavily on imports; Oil import is critically important to its economy. Rising oil prices in international market may result in pressure on foreign reserves, but this has always proved to be a temporary phenomenon.

Sri Lankan default of external debt also created negative perception. But Sri Lanka’s debt profile was different from Pakistan. Private sector debt of Sri Lanka is proportionately very high in comparison to Pakistan. Sri Lanka’s commercial debt was about 50% of its total liabilities, while this proportion is only 13% in case of Pakistan

Private sector commercial debt servicing is the first priority of every country to keep the credit rating in tact. In case of other bilateral or multilateral loans, diverse options are available on circumstantial basis.  

Pakistan external debt to GDP is 36%, while remaining debt is in local currency. Sri Lanka’s  external debt to GDP is 59%. This position is too heavy to service  and to guard off against default in stress situation. On the contrary Pakistan’s economy is much bigger, while commercial  debt is comparatively lower.

 

Country-to-country External Liabilities

Historically, Pakistan serviced all its external liabilities under various stress situations, like financial meltdown of 2009 and external flows crises of post nuclear tests in 1998. Foreign exchange reserves had hit record low during 1998-99 due to temporary sanctions. Under each scenario, debt servicing was not affected.  

Its not only the financial data that explains Pakistan’s resilience in servicing its external debts. Here we discuss the reasons that Pakistan will not default its foreign commitments.

The Regional Trade and Diplomacy Factors

Pakistan enjoys far more regional significance in foreign relations, particularly dominated by common interests with Kingdom of Saudi Arabia and China. Pakistan has built up strong defense ties with regional powers. Its exports also include defense equipment. China and Pakistan are keen to expand CPEC by including other regional countries. In fact one of the reasons of unusual hike in trade deficit during the last couple of years was related to imports for CPEC development. Both China and Pakistan are cognizant of this gestation time lag and replenishment of  the foreign exchange flows that emerged as a result of CPEC.

The default, if any will result in destabilizing regional trade. If a country defaults, its banks may not be able to maintain their counterparty limits, leading to blockage of bilateral import bills. This systemic impact results in losses to regional trade partners. Pakistan also provides key trading support to Afghanistan for procuring its subsistence goods.  With no stable governance structure and being a land locked country, Afghanistan relies on trade from Pakistan shores with the support of financial system of Pakistan. So Sovereign default will not be an issue of one country alone, it’s a matter of regional concern. Hence a deterrence factor.

 

IMF Factor

IMF projections on external debt servicing of Pakistan include outflows on account of bilateral liabilities also. However, these are mostly rolled over by such countries on the back of common interest factors. So the projected outflows in 2022, 2023 will sufficiently come down.

Under the IMF program, Pakistan is pursuing timely debt servicing strategy along with reduction in overall debt float. External debt in Sept 2022 has recorded reduction in external liabilities,  albeit at a smaller scale, to start with.  

In fact IMF program is a safety valve against any  credit erosion. Pakistan is committed to IMF program, and is paying the cost, whatever necessary to remain afloat.

 

The Eurobond Maturing December 05, 2022 being repaid.

USD denominated Bonds/sukuk Commercial loans of Pakistan are around USD 17 billion in September 2022, which is 13% of total external liabilities of the country.  All commercial loans have been timely serviced in the past. The bond with face value of USD 1 billion maturing on December 05, 2022 is also being repaid ahead of time (on December 02, 2022, as confirmed by Governor State Bank of Pakistan). So unlike market perception and speculations, positive outcome is now a reality and so Pakistan Default is not happening.

 

Way forward

Pakistan on November 29, 2022 received a loan tranche of $500 million from Asian Infrastructure Bank. A Chinese commercial bank is also approached to review the possibility of giving more loans. Bilateral negotiations with regional countries are also in progress.

Pakistan is committed to IMF Program and taking all fiscal and monetary measures necessary to combat Post-Covid slow down of economy.

A long term political strategy is also needed to enhance export based productive resources and foreign remittances so that reliance on external debt be minimized.