What if Pakistan defaults?
https://arab.news/936q8
A black hole’s “surface”, called the event horizon, is the point where any celestial object reaching it cannot escape the gravitational pull of the cosmic body. As the object hurtles into the dark abyss, it gets torn apart into its smallest subatomic components. The black hole serves as a metaphor for the devastation that can befall a sovereign that descends into default on its debt obligation. The event horizon can be equated to that point when it becomes impossible for a country to avoid doing so.
Whether or not Pakistan defaults is contingent on the government successfully renewing the stalled Extended Fund Facility (EFF) program agreed with the International Monetary Fund (IMF). Access to international credit markets, funding from international multilateral agencies such as the World Bank and Asian Development Bank, and bilateral financing arrangements are all tied to this.
Unfortunately, the discussions with the Fund to conclude a staff level agreement (SLA) suffered a setback following the submission of the FY 2022-2023 federal budget to the National Assembly on June 10. The uncertainty that has followed in its wake about revival of EFF has thrown the markets into a tailspin. After the budget reveal, KSE100 has nosedived over 1000 points (over 2%) and the exchange rate has fallen by over PKR 6 against USD. The State Bank of Pakistan foreign exchange reserves that stood at only USD9.2bn on June10 continues to fall. There are unconfirmed reports of international banks requiring 100 percent margin provision against letters of credit. There is an increasing sense of foreboding that SLA may not materialize and the default event horizon gets ever closer.
As defined by the credit ratings agencies Standard & Poor’s (S&P), a country will default if it breaks a contract on a debt obligation or “tenders an exchange offer of new debt with less favorable terms than the original issue”. Should this happen, the ramifications for Pakistan will be devastating, as can be witnessed from the nightmarish chaos unleashed in Sri Lanka. Insolvency will cascade into the impoverishment of large parts of the domestic economy with accompanying destructive social dislocation. The government and its institutions will suffer immediate loss in legitimacy among Pakistanis and international lenders.
The risks associated with default should be unacceptable for policymakers to ever allow it to happen. The government should be alert to the possibility that it will face much greater public outrage as a consequence of default than if it were to implement the “additional measures” that the Fund has requested for reviving the EFF program.
Javed Hassan
The financial sector will first bear the brunt of the adverse consequences. There is likely to be a steep devaluation of the Pakistan Rupee and a stock market crash. Should depositors fear for the safety and value of their foreign exchange savings, there could even be a run on such accounts, as well as on Roshan Digital Accounts (RDAs) held by overseas Pakistanis. With confidence in the overall financial system faltering, it would not be inconceivable to witness some domestic banks face liquidity crunch. Even if that is avoided, the imposition of capital controls would be inevitable to prevent a stampede of conversion of PKR into other hard currencies.
The impact of default is likely to ripple throughout the wider economy. Exporters and importers would no longer be able to obtain trade credit, causing shortages of crucial consumables and industrial inputs. As households experience increased unemployment, the level of overall consumption will fall, and therefore aggregate demand contracts. This in turn would mean even more workers will lose jobs, which will only exacerbate the demand contraction. It is far from certain that following a default, the state will be able to renegotiate the terms of the outstanding loans to enable it to revive access to international credit facilities, and work towards transforming the country’s economy in the long run without the burden of crippling debt.
The risks associated with default should be unacceptable for policymakers to ever allow it to happen. The government should be alert to the possibility that it will face much greater public outrage as a consequence of default than if it were to implement the “additional measures” that the Fund has requested for reviving the EFF program. This includes fully eliminating all subsidies on petrol and diesel sales by further hiking their prices. The government is also expected to implement power tariff hikes to the tune of Rs7.91 per unit as well as make fuel adjustments on a quarterly basis as determined by National Electric Power Regulatory Authority (NEPRA).
The Fund is reported to be unconvinced by the Personal Income Tax (PIT) proposals in the budget and has indicated that it would like additional Rs125bn revenue generation rather than the provision of Rs47 billion tax relief in the budget. Finally, the fund may also want more visibility on when the budgeted petroleum levy figure of Rs750 billion will be collected.
Time is running out to take corrective actions and restore credibility with the IMF to conclude an SLA. Failing to do so could mean the country goes beyond the point of no return and defaults. Such an outcome must be avoided at all costs.
– Javed Hassan is an investment banker who has worked in London, Hong Kong, and Karachi. He tweets as @javedhassan. The views expressed in this article are author’s own and do not necessarily reflect the editorial policy of Arab News.
