Pakistan: The default response
Before the recent by-election in Punjab, the present government seemed to be coasting towards completing its constitutionally mandated term. The results of the by-elections not only surprised everyone, but have upended the balance of power in Pakistan’s most-populous province.
Against the dark backdrop of the events in Sri Lanka, exponentially rising political instability has, once again, forced many to wonder whether Pakistan is heading towards default.
The government and the State Bank of Pakistan have been forthcoming, albeit somewhat belatedly, in ameliorating these anxieties. Still, it is very important to understand what is default and whether there is any probability of Pakistan defaulting.
Developing countries like Pakistan require funds from various external sources every year in order to bridge their external financing gap. A significant component of Pakistan’s external financing needs originates from the economy generating current account deficits, year after year. Another big component of external financing needs is the external loans that need to be serviced or rolled over.
When a sovereign country’s government fails to make a scheduled interest payment on the borrowed loans then the government is said to have defaulted.
In theory, a government cannot default on loans taken in the local currency because the government can ‘print money’ to pay off local creditors, even though such money printing can lead to hyperinflation. For this reason, the ability to service external loans becomes the benchmark of an economy’s financial health. Since the interest payments on external loans have to be made in dollars, whenever a country starts losing its foreign exchange reserves rapidly, something that has happened in many emerging economies recently, alarm bells are sounded by various credit rating agencies like Fitch Ratings and Moody’s.
Even though sovereign defaults are bad news, they, surprisingly, are very common. Since 1960, 147 governments have defaulted on their obligations, according to the joint Bank of Canada-Bank of England database on sovereign defaults. In the event of a default, a country’s currency suffers from devaluation, loss of economic growth as well as a loss of credibility, thus making it harder for the country to borrow the money it needs in international markets. After a country declares it has defaulted, usually, the outstanding debt is restructured or in some cases the outstanding amount is even reduced, but only after tough and protracted negotiations with international lenders.
In most cases where sovereign default has taken place, poor decision-making in the midst of a political crisis can be nailed as the number one reason.
Argentina remains a repeat offender when it comes to sovereign defaults having defaulted as recently as 2014 and in 2001-02. Analysts believe that the problem with the Argentine economy remains that country’s fractious politics, where Peronist leaders allegedly often shun fiscal discipline in favour of populist measures.
Sri Lanka’s default was also brought about by poor economic decision-making in the midst of a political crisis, whereby Sri Lankan leaders burned through their foreign exchange reserves even as their foreign exchange earnings that came primarily from tourism, dried up.
In the case of Greece, a new government, despite tough economic challenges, rejected bailout terms that then led to a liquidity crisis. Greece defaulted in 2015 when its interest payments ran 20 days late.
At the beginning of this year, global economic conditions took a turn for the worse, especially as the Russia-Ukraine crisis brought about a commodities super cycle.
Pakistan’s economic decision-makers did all that they could to contain the damage but as the political situation worsened in late March, priorities switched and Pakistan’s foreign exchange reserves fell precipitously. Taking stock of the problem, the new government was quick in starting negotiations with the IMF. But, for them, too, political considerations came into play and now with the recent bout of political instability after the Punjab by-elections, some analysts are again becoming concerned about the health of Pakistan’s finances.
In terms of numbers, Pakistan’s total public debt at 71 per cent of GDP is relatively contained compared to Sri Lanka’s at more than 100pc. Pakistan’s external debt is also relatively low at 36pc of GDP, primarily held by the public sector and has been sourced from concessional sources. Moreover, Pakistan’s interest rate-growth differential, a key statistic for debt dynamics and sovereign sustainability analysis is negative 4.8, implying Pakistan’s overall debt ratios can be reduced even in the absence of primary surpluses, whereas Pakistan is on track towards generating a primary surplus at the end of this fiscal year.
Though there have been fiscal slippages in the past, especially as the previous government did not pass on the increase in global oil prices to the consumers, Pakistan’s fiscal management has been sounder than Sri Lanka’s. This government, it appears, is planning to maintain fiscal discipline that will assist with checking inflation and with getting a grip over the current account. Some provisional numbers indicate that the government has managed to generate a current account surplus for July. All in all, against a financing need of $33.5 billion this year, total financing of about $36bn is available.
At this point, economic policymakers need to ensure that Pakistan stays in the IMF programme, gets the money from friendly countries and maintains fiscal discipline as rupee depreciation though painful for causing inflation, will fix trade imbalances by reducing the current account deficit even further.
Of course, all this will become meaningless if Pakistan’s political parties fail to reach an agreement on how to share and transfer power in the next year. Political instability will turn into political chaos and will force policymakers to put political considerations on the top of their agenda just like they did in Argentina, Sri Lanka and Greece. Perhaps, there is a need to de-hyphenate politics from economics in the short term. To that end, the government should take the initiative and call a conclave of all political parties on the economy.
The writer completed his doctorate in economics on a Fulbright scholarship.