‘Pakistan unlikely to default on foreign debts’

KARACHI: Pakistan is expected to avoid defaulting on its international debt obligations, helped by its favourable debt composition and a manageable external funding gap, a brokerage report stated on Monday.

The question of whether the cash-strapped Pakistan will default on its debt has been a hot topic as the central bank's foreign exchange reserves are depleting and likely to fall below $5 billion soon on a repayment of over $1 billion in foreign loans early in the current month.

Moreover, the International Monetary Fund (IMF) loan programme is on hold, and there has been no new funding from friendly countries so far. The foreign reserves held by the State Bank of Pakistan have fallen to $5.8 billion; hardly enough to cover a month’s imports.

Coming out of the current predicament appears to be one of the most difficult challenges, despite the fact that Pakistan has had 22 IMF programmes over its 75-year history. Seeking a bailout and depleting reserves are not rare occurrences for the country.

While the government is attempting to strike a balance to preserve its political capital for future elections in 2023, the lender of last resort (IMF) is taking a strong position about tough adjustments.

The financial markets are jittery on the delay in the IMF programme, which could lead to a debt restructuring or a default. However, according to a report from Ismail Iqbal Securities, the country is less likely to default because of its less reliance on external borrowing, lower dependency on Eurobonds, and manageable external financing gap of the financial year 2023.

To determine likelihood of default and the effects in the case of a default event, the report examined five default occurrences and compared them to Pakistan's current condition. Argentina, Zambia, Greece, Ghana, and Sri Lanka were among the countries included in the sample. Each of the nations struggled with a mix of political, fiscal, and debt sustainability problems.

“Pakistan has lower external debt to GDP of 31 percent compared to our sample of default countries (average external debt to GDP of 59 percent). High external debt exposes the country’s public finances to exchange rate shocks whereas dependency on Eurobond makes refinancing debt very challenging. The absence of both factors makes Pakistan's debt mix less vulnerable,” it noted.

However, avoiding default would not be the end of the challenges as it would require painful adjustments, leading to currency devaluation, higher inflation, and gross domestic product (GDP) contraction in the near term, it mentioned.

According to the report, the financing gap will be $5.3 billion in FY2023. It is assumed that the country will remain committed to the IMF programme, all multilateral flows apart from conditional RISE II, a policy loan for budgetary support and a PACE loan (Pakistan Programme for Affordable and Clean Energy) will materialise, and bilateral deposits will be rolled over.

On the commercial side, the report has projected that $3.3 billion in loans pertaining to China to be rolled over, envisaging zero inflows from Eurobonds on the country’s poor sovereign debt rating and global macroeconomic issues. “Based on our assumptions, we estimate inflows of $25.4 billion against the requirement of $30.6 billion ($23bn debt repayment + $7.6bn current account deficit), thus the financing gap comes at $5.3 billion.”

Pakistan is likely to finance the gap through a $3 billion deposit from Saudi Arabia, $600 million from an additional Saudi oil facility, and a $1.45 billion Chinese swap facility, according to the report.

Beginning in 2022, Pakistan's structural fragility became clear. The rupee lost 28 percent of its value versus the US dollar in the year. Mega floods, which caused extensive crop loss and elevated inflation to its worst levels since the 1970s, made the situation even more difficult.

The default risk for the country had increased to an all-time high in 2022 and remained alarmingly high throughout the year. To reduce demand, the benchmark interest rates were increased by 625 basis points to 16 percent, and import restrictions were imposed to slow the loss of foreign exchange reserves.