With the deadline for Pakistan’s International Monetary Fund (IMF) programme rapidly approaching (Jun’23), the program’s successful completion is in question.
Arif Habib Limited (AHL) claims in a detailed analysis that Pakistan has $5 billion in external debt servicing commitments and is therefore likely to default, as assistance from friendly countries is sometimes contingent on the IMF’s tacit consent.
Pakistan is in hot waters due to its debts
Pakistan faces massive debt commitments until June 2024, but its foreign exchange reserves are perilously low at USD 4.3 billion.
A shortfall of $5 billion is expected to prevent Pakistan from meeting its external debt servicing requirement of $27 billion in FY24, even in the most optimistic scenario where the country might receive support from bilateral friends (Saudi Arabia, UAE, and China) in the form of rollovers and fresh funding and also run a balanced current account.
This makes the gravity of the problems and threats we face in the future abundantly evident. A lack of progress with the IMF would significantly increase the likelihood of a sovereign default, as the backing of friendly countries is generally contingent on the IMF’s tacit consent.
There is still a chance of sovereign default, even if the research assumes that Pakistan would avoid it by maintaining dialogue with the IMF and receiving aid from large bilateral creditors.
If Pakistan defaulted on its debt, it would undoubtedly have trouble obtaining further funds because lenders would be wary of the significant risk involved.
In addition, even if Pakistan is successful in securing a loan, the interest rates associated to it are likely to be very high, thus increasing the burden of markup servicing for the government.
In 1998-99, when the country was on the verge of default, the country took a number of steps to raise funds from outside sources and restructure some of its debt.
Pakistan’s economy is highly dependent on imports
If Pakistan defaults on its debt, the country may have trouble importing even necessities like petrol, machinery, and medicine.
As of 10MFY23, over 73.4% of all imports are considered necessities. Not having access to necessary raw materials, experiencing energy shortages, and having export orders cancelled or moved to more reliable rivals are all potential outcomes in the event of a failure on payments.
The textile industry, which accounts for 60.8% of Pakistan’s exports as of 10MFY23, is heavily reliant on imported raw materials like cotton.
In addition, Pakistan is already under substantial inflationary pressure, with headline inflation hovering at 28% FYTD; this pressure would be amplified greatly in the event of a default.
There is a risk of a severe drop in GDP and currency devaluation. Pakistan’s GDP is predicted to decline to 1 percent in FY23 as the country continues to struggle economically due to factors such as high commodity prices, political instability, and a weak currency. However, the GDP is expected to decrease if there is a default.
Local Bank Vulnerability to Default
Since Pakistani banks have a disproportionate amount of their assets invested in government treasuries (50%) and their loans to government-owned enterprises (6%), they are very vulnerable to the effects of a sovereign default on the local banking industry.
If Pakistan defaults on its debts, its creditors may impose economic consequences. Legal action could be taken by foreign creditors to recoup unpaid debts or coerce the country into meeting its obligations. Pakistan already has a very low credit rating, so a default may cause it to drop much further, making it very difficult for the country to borrow money in the future.
Importantly, Pakistan is currently rated as a speculative or “junk” grade Caa3 (Moody’s) / CCC+ (S&P).
Debt Restructuring as a Post-Default Strategy
If Pakistan were to default, its massive debt servicing obligations over the next two to three years would necessitate a massive debt restructuring process. As of the end of March 23 (28 percent of GDP), the entire amount of public external debt outstanding was USD 96 billion, of which USD 37 billion was to multilateral creditors who are unlikely to be included in any debt restructuring effort.
Following Sri Lanka’s example, Pakistan would need to hold separate negotiations with China, other bilateral creditors, and the Paris Club to develop a restructuring plan that would also be covered by the IMF.
It’s important to put things in context, something that was stressed in AHL’s study “Debt reprofiling or restructuring?” Over FY24-27, Pakistan would need to pay back USD 39 billion in short-term bilateral borrowings, most of which come from friendly countries like Saudi Arabia, China, and the United Arab Emirates and their commercial banks.
Pakistan have some hopes for the betterment of economic conditions
The principal amount of USD 13 billion borrowed from friendly countries is expected to be renewed annually. The International Monetary Fund is another option. A defaulting Pakistan, according to the research, would have to implement a new long-term IMF programme to establish macroeconomic stability through robust policy measures and substantial structural reforms before any conversations on debt restructuring could even begin.
Pakistan’s strategic and economic ties to China are so strong that it makes China its most significant bilateral partner. Since it is the country’s largest bilateral creditor, it will be pivotal in any post-default scenario because it is responsible for almost 30% of the country ‘s total external debt of USD 96 billion.
While China is expected to play a helpful role in assisting Pakistan in avoiding a default event, its participation in the aftermath of a default will be even more crucial, especially on two major counts.
First, support from major creditors, and China in particular, is likely to be a vital requirement for any new post-default IMF programme, as was shown in the case of Sri Lanka, where a restructuring was necessary after a default. In a post-default scenario, China is also likely to make similar promises. This might help to ease the situation that the country is facing.
To read our article about “Pakistan not finishing Iran gas project will risk $18bn fine” click here.
