Pakistan must stop pretending the possibility of default doesn’t exist
https://arab.news/ja9dx
Pakistan’s precarious debt servicing position and the uncertainty regarding the outcome of the overdue IMF program’s 9th review have heightened the risk of sovereign default. Finance Minister Ishaq Dar’s obsession with pegging the exchange rate has contributed to accelerating erosion of foreign exchange reserves and creating a shortage of hard currency in the retail market. The State Bank of Pakistan’s foreign exchange reserves in the last week of December stood at an eight-year low of USD 5.8 billion. The administrative controls limiting the issuance of letters of credit by banks have led to the choking of business activities which has increased unemployment.
A sudden and disorderly declaration of insolvency will exacerbate the costs to an economy already teetering. Policymakers, therefore, need to consider orderly debt restructuring even if it entails being branded with the stigma of default. Rather than pretend that such a possibility does not exist, they should look at how to preemptively minimize the fallout of the credit event and chart a path for revival thereafter. Although restructurings usually occur after default, Pakistan with over 90% of its external liabilities being either multilateral or bilateral loans could have aimed at preemptive restructuring so that its outstanding debt instruments were exchanged before the government misses any payments, but that boat has now sailed. The International Swaps and Derivatives Association (ISDA) is likely to treat the Pakistani restructuring as a credit event since rapidly declining reserves, international risk indicators such as secondary market Eurobonds pricing and sovereign CDS spreads, as well as the country’s sovereign ratings, have deteriorated to levels that have cut off its access to international credit markets. It would also be in Pakistan’s interest that the restructuring is “binding on all holders” or in other words, it is mandatory for all creditors.
It may provide cold comfort, but Pakistan is not unique among emerging market countries to face a perfect storm that has set off debt distress. The IMF October financial stability report notes: “In emerging markets, rising rates, weak fundamentals, and large outflows have pushed up borrowing costs, particularly for frontier economies, with a heightened risk of additional defaults”. Over the past few years, Mozambique, Lebanon, Suriname, Ecuador, Sri Lanka, Ukraine, and Zambia have defaulted or restructured their debts. Recently Ghana announced a debt repayment suspension and began restructuring negotiations with creditors.
It may provide cold comfort, but Pakistan is not unique among emerging market countries to face a perfect storm that has set off debt distress.
Javed Hasan
Pakistan may want to follow suit. As Bristol University economist, Dr. Ahmed Pirzada says: “its external debt servicing for FY23 stands at 60 percent of its exports, and is higher than any 'group' of countries one looks at, except perhaps countries already facing debt distress… The situation is made worse by the fact that Pakistan’s foreign reserves with the State Bank now only cover less than one-third of expected debt repayments in the next twelve months As a rule of thumb, the Greenspan-Guidotti rule suggests this ratio should be close to one.”
Thus, there is a strong case for debt restructuring with the clear objective to agree on the terms of a debt exchange that will provide some form of debt relief and solve the distressing situation. Kenneth Rogoff, professor of economics at Harvard University, argues that: “where the inherited debt burden is exceptionally large, it is by no means obvious that the debtor country’s low- and middle-income citizens fare better under an IMF-style adjustment plan than they would do under an outright default, or equivalently a rescheduling of repayments that lower the value of the debt.” It is indeed the case that where such episodes are amicably resolved between the debtor country and the creditors, the defaulting country can see a rebound in economic activity in the following years (Trebesh and Zabel, European Economic Review, 2017).
Although sovereign debt restructuring is a complex and often challenging process that can take a significant amount of time to reach a successful resolution, if combined with meaningful reforms it is the only sustainable way forward. The former Chief Economist Planning Commission, Dr. Ahmed Zubair, contends that the time may have arrived for a “grand development bargain that is underpinned by a credible fiscal framework. It requires immediate and orderly moratorium of debt servicing accompanied by negotiations to restructure both domestic and external debt as well as IPP contracts.”
Pakistan needs to embark on and successfully conclude debt restructuring, where the final agreement with creditors is likely to require a reduction in overall government expenditures and institutional reforms that broaden the tax base. It is imperative that the reforms are owned by political forces that have the people’s mandate. Herein lies an opportunity for political parties to take necessary tough decisions that electoral exigencies have previously prevented from being implemented. However, for this to be realized, policymakers must take advantage of that tide of events to embrace the fear of default and take the current that serves to transform.
– 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
