A perfect storm brews in Pakistan
https://arab.news/rjhuj
A perfect storm is a severely turbulent weather event arising from a rare combination of adverse meteorological factors. It also serves as a metaphor for Pakistan at present, where high inflation due to soaring food and energy prices, combined with a financial crisis amidst political gridlock, could plunge the country into a vortex of debt default and civil strife.
The financial crisis is a chronicle of large external trade imbalances overlapping with unsustainable fiscal deficits that has been repeated a number of times in Pakistan’s history. The latest episode has its origins in the previous government’s pro-cyclical stimulus in April 2021 just when it should have been applying checks on a fast recovering economy after the Covid-19 pandemic. The economic expansion resulted in an escalating trade deficit that was exacerbated by soaring global prices of several strategic commodities.
Already tight global energy and food commodities supplies were further jolted by the Russia-Ukraine war. In order to protect vulnerable segments of society from the price shock, former Prime Minister Imran Khan’s government announced a relief package that not only cut petrol and diesel prices by PKR 10 per litre on March 1, but also fixed them till the fiscal year end. The cost of the subsidy for the period was estimated to be worth PKR 250-280bn, or almost 0.5 percent of GDP. Resultantly, further disbursements through Extended Fund Facility (EFF) were put on hold as the subsidy and fixed pricing breached the terms agreed by Pakistan with the International Monetary Fund (IMF) to link domestic petroleum prices with international markets as determined by the Oil and Gas Regulatory Authority (OGRA).
The interruption of the EFF program and political instability caused by the vote of no confidence tabled against then Prime Minister Imran Khan triggered a deterioration in Pakistan’s risk rating. The one-year credit default swap rate, which is a financial instrument that measures the risk of default on dollar denominated debt, increased from 4.96 percent on March 4 to 8.61 percent on March 8. The spread further widened to 8.98 percent on May 12.
Pakistan is effectively shut out of the international debt markets.
Javed Hasan
The yield to maturity for the USD-denominated September 2025 dated Pakistan bond increased from 12.93 percent on March 4 to 14.76 percent on March 8. The yield on May 12 was 15.79 percent, which infers a deterioration in risk perception since March. The implied rating by the international bond markets is at only a few notches above D, or default rating. Most institutional investors are mandated not to invest in “hooks”, that is, countries with ratings that are CCC or lower. Pakistan is effectively shut out of the international debt markets.
Pakistan is expected to pay around $35bn in debt over the next two years. Around two-third of this takes the form of government-to-government debt and loans from Chinese commercial banks. If Pakistan fails to revive the EFF program, bilateral debt due for repayment is unlikely to get rolled over. The State Bank of Pakistan forex reserves on May 6 was USD10.308bn. Excluding USD3.2bn of Saudi Arabian deposits, which cannot be used to meet external obligations, only USD 6-7bn of liquid reserves are available to draw upon. With a monthly current account deficit of almost USD1.5bn and further USD2bn loan repayments due over the next 2 months, Pakistan is only a few weeks away from default if there is no fresh injection of funds.
The consequences of default can be gauged from the events unfolding in Sri Lanka. The island nation defaulted on its $51bn foreign debt on April 12 for the first time. Faced with shortages of fuel, electricity, food and other essentials, the people have come out on the streets demanding the resignations of President Gotabaya Rajapaksa and his brother, Prime Minister Mahinda Rajapaksa. The latter stepped down on May 9 after a day of chaos and violence, which culminated in police imposing curfew across the country. Eight people died and more than 200 were left injured amid violent attacks that have seen mobs set fire to buildings and vehicles. The situation remains volatile and uncertain. It is unclear how the country will extricate itself from the financial and political quagmire.
The government needs to move fast to avert such a scenario in Pakistan. Currency and equity markets are jittery. Between April 12 and May 12, the stock market index, KSE100, has declined by over 3000 points, or 6.5 percent, and PKR went from 183 to 192 against the USD. With the former Prime Minister Imran Khan’s resurgent popularity, the government appears hesitant to implement the conditions set out by IMF to revive EFF. While the government may want to avoid reversing the petroleum subsidies and impose new taxes as these measures are likely to boost Imran Khan’s electoral prospects, failure to resuscitate EFF will result in economic implosion. Time to act is running out.
– Javed Hassan has worked in senior executive positions both in the profit and non-profit sector in Pakistan and internationally. He’s an investment banker by training.
Twitter: @javedhassan
