Abstract
Pakistan’s situation in terms of the economy and security is wanting. The autumn capital crisis was an indicator of the bleak situation the country is in, in terms of repayment of its sovereign debt. This paper has therefore sought to carry out an analysis of the risk of default by Pakistan. Various sources of literature mainly from organizational reports and the news media provided the information for analysis to shed light on the default risk factor of Pakistan. The paper has comprehensively tackled both the security and economic situation of the country as far as sovereign debt repayment is concerned.
Introduction
For the last three to four years, Pakistan has faced a serious capital crisis that has seen the country’s economic fortunes plummet. The country, like its peers in the region, faces many security challenges internally, coupled with unstable neighbors such as Afghanistan that do little to encourage economic growth. Pakistan’s economy has experienced long periods of sound economic growth as well as negative growth cycles that have threatened the survival of the entire economy. The perennial security issues from militant groups have not augured well with investments that are critical to the country’s economic growth and balance of payments.
The autumn of 2008, however, marked the peak of Pakistan’s economic woes forcing President Asif Ali Zardari’s government had to seek help from multilateral donors for an injection of capital that helped the country avoid default on its sovereign debt. Then, the IMF and the Pakistani government agreed on a loan of $7.6 billion to help it pay its external debt albeit in the short-term (Joyner, 2008). The assumption was that the economic situation will improve, and the country will be able to meet its economic and financial obligations in the longer term.
Subsequent reports after the “bailout” have painted a rather grim picture about the country’s position on its ability to pay its sovereign debt. This research will focus on the analysis of Pakistan’s sovereign debt situation and the extent to which default is likely to occur. Hypothetically, many analysts believe the risk of a Pakistan default is still eminent despite noticeable progress in the areas concerned. To meet the above goal, the researchers used a clear hypothesis as highlighted in the section below. Additionally, there was a somewhat in-depth analysis of literature on the subject, methodology clarifying the study criteria, a discussion of the findings, a conclusion and a suggestion of areas the author feels give the basis for further research.
Hypothesis
The hypothesis that Pakistan is still plagued by economic problems that exacerbate its sovereign debt risk will be the basis of the study. To achieve this research’s objective, it is important to note that analysis of all literature on Pakistan’s debt default took place, and important conclusions were subsequently drawn. The purpose of this analysis will be to determine the Pakistani risk of default based on the current economic conditions.
Methodology
The analysis primarily focused on the review of secondary literature materials. The research carried out an in-depth review of available literature on Pakistan’s sovereign default status from the last decade to come up with the content in the literature review. It is important to note that most of the information came from published reports from organizations such as the International Monetary Fund and respected news outlets. The research relied on the above materials because the apparent dynamic nature of events surrounding Pakistan’s sovereign debt woes provided little room for the publication of books that detail the situation comprehensively.
Literature Review
This literature review will analyze information accumulated in the lead-up to the genesis of the debt crisis in Pakistan and the possibility of default in the near future. Additionally, the literature will be seeking to paint the current situation picture as far as sovereign debt and risk of default are concerned.
Before the capital crisis, Pakistan had experienced phenomenal growth averaging above 7% from the beginning of the last decade. Growth, however, declined towards the end of the decade plummeting to 5.8% in the 2007/2008 fiscal year (Martin & Kronstadt, 2009). Furthermore, the country was negatively affected by a fall in global energy and food prices and a decline in foreign exchange reserves that according to IMF fell from $14 billion to $3.4billion by 2008. The fall was primarily due to a fast deteriorating current account balance that meant the country was in danger of defaulting on its sovereign debt (Martin & Kronstadt, 2009).
The risk of defaulting was highest in the 2007/2008 fiscal year as captured by various reports and news media. This was partly due to the political upheavals caused by the assassination of former Prime Minister Benazir Bhutto. According to Biggadike & Kuo (2007), the risk of default rose with the spread of violence after the assassination. Investors held back causing stocks, bonds and the currency to plummet raising the cost of protecting the country’s debt by 100 basis points at the time as violence tripled the cost of credit swaps in 2007 (Bloomberg, 2007). Biggadike & Kuo(2007) assert that Pakistan’s outstanding bonds and loans totaled $22.4 billion in 2007 rising from 430 basis points before the assassination-related violence to 530. At the time, the country spent over $500, 000 to protect the country’s $10 million of the country’s debt to avoid default over a five-year period. In November 2008, Standard & Poor’s cut the credit rating of Pakistan from CCC+ to CCC mainly due to what the agency termed as high risk of defaulting on external payments (Qayum & Sharif, 2009). The rating level was the lowest in ten years, perhaps an indication of the severity of the default risk that the country faced at the time.
The situation above warranted emergency measures that saw Pakistan seek credit from the IMF and other friendly governments, including China and the US and Saudi Arabia. It has been close to three years since the peak of the risk of default and the lowering of country’s credit rating. Since then, mixed reviews on the country’s risk of default have taken place.
In September 2008, the Secretary of Economic Affairs Division (EAD), Furrukh Qayyum declared that the country was out of default risk (Iqbal, 2008). Qayyum attributed the improved situation to the reduction in the prices of oil in the world market and reduction in its subsidies, which proved critical in the country’s management of foreign assets (Iqbal, 2008). The 2010, IMF Staff Country Report seems to agree with the above evaluation citing improved investor perceptions of Pakistan’s sovereign debt. The report points out o some recovery in some sovereign credit risk indicators following the improvement of perceptions of liquidity risk (IMF, 2010). Additionally, the country’s sovereign debt rating by S&P was raised in December 2009 to CCC+ a sign that any near-term debt service stress was highly unlikely (IMF, 2010).
In 2010 CMA Global released a global sovereign credit risk report that reviewed the sovereign debt situation of the country positively. According to the report, Pakistan’s sovereign debt holds a B rating from B- that it had in the fist quarter of 2010. The report quoted analysts who asserted that the country’s foreign exchange reserves were worth more than five months of imports, a development t that investors termed as a positive sign in default risk scale (Nasir, 2010).
Despite the improvements however, independent observers and analysts including IMF and CMA acknowledge that Pakistan still has a long way to spur confidence among investors. There is a consensus among analysts suggesting that the country has withered the effects of the global financial crisis and the autumn capital crisis and has made progress concerning the servicing of sovereign debt. Even so, there still is a risk of default given the fledgling growth and weak recovery that the country’s economy is experiencing. In the fist quarter of 2010, the CMA report ranked Pakistan the third riskiest sovereign debt behind Venezuela and Argentina (CMA, 2010). The country ranks fourth as the worst performer in Asia as far as sovereign debt is concerned scoring 10.3% against Kazakhstan’s 32.9% (CMA, 2010). It is important to note that Pakistan was a new entry to the top ten tier in this ranking, perhaps an indication of the risk of default the country’s sovereign debt has acquired.
The IMF Country Staff Report of 2010 too acknowledges that the progress made in Pakistan’s economy, and sovereign debt has been modest. The reports cite secondary market illiquidity while the country finds it difficult to re-establish its access to the market owing to the closure of primary debt markets for countries that rank below the investment grade (IMF, 2010). The report also cites concerns about political stability and uncertainty associated with public finance and external sustainability factors that have persisted among investors giving little confidence to the country’s sovereign debt. There are phenomenal underlying risks according to the report concerning the financial and economic outlook of Pakistan. Additionally, the resource constraints and tail risks, especially those emanating from the prevailing global economic environment have significantly hampered Pakistan’s sovereign debt recovery.
According to the IMF report, Pakistan’s EMBIG spread remains volatile with an average of 1964 bps as of February 2009. Furthermore, credit default swaps still indicate high default risk moderating at 3886 bps by February 2010 (IMF, 2010).
Discussion
There are sufficient indicators that the worst of the sovereign debt crisis in Pakistan is over. Some observers believe the country is unlikely to default in future given its small portion of foreign assets (Walayat, 2010). However, the slow process of recovery of the county faces many obstacles. The country now more than ever faces a big obstacle in terms of security. The government of Pakistan has been unable to impose law and order in some areas, a situation that has severely limited economic activity. The current tensions with the US, an important donor and bilateral partner and the unwillingness of China to commit large-scale aid do not work to Pakistan’s advantage. Factoring in the security issues and the possibility of delay in bail out in case of another capital crisis, Pakistan’s risk of default becomes high. In 2008, the county stated that they needed over $10 billion in a period of three years to overcome its
sovereign debt issues. Sine the advancement of the loan the country’s desire to revise the performance goals downwards is an indication of the instability that is likely to increase the risk of default. There were reports in 2009 that showed a rise in the current account deficit that hitting $12.1 billion, way above the IMF performance goal highlighting the need for further assistance (Martin & Kronstadt, 2009).
In a nutshell, any foreign investor, especially in the sovereign debt of Pakistan should carefully consider the challenges the Pakistani government is facing in its approach to political, social and economic problems facing the country. The increasing violence coupled with underperforming economic indicators will likely produce a ripple effect that will increase the risk of default in the Pakistani sovereign debt.
Conclusion
The perennial security problems of Pakistan do not show any signs of abetting any time soon. The political and security risks in the country do little to encourage economic growth and investor confidence. Given the role the two factors play in economic growth and development and the ripple effect they are likely to have in helping the country contain the default risk, the current situation is not favourable at all. There is potential for default if the current political and economic climate persists.
It is highly unlikely that Pakistan will wean itself of foreign aid from multilateral aid organizations and friendly governments any time soon. That in itself is an indication if the precarious situation that the country is in and only adds to speculation about the country’s ability to service its sovereign debt.
Suggestions for future research
There is no one perspective that can comprehensively tackle the complexities surrounding Pakistan’s sovereign debt issues. It is important, for instance, to carry out an in-depth research on the country’s security situation and its effects on economic growth and development. Additionally, it is important to carry out research on the shaky political situation of the country and its effects on the economy, sovereign debt issues and its overall wellbeing. Finally, in-depth research and analysis are necessary to determine the criteria and effect of credit-rating agencies on Pakistan and if their effect is worth it.
References
Biggadike, O. & Kuo, P., 2007. Pakistan Default Risk Rises to One-Month High on Bhutto Killing. Bloomberg online, Web.
Bloomberg, 2007. Pakistans default risk rises 100 basis points: BENAZIR BHUTTO ASSASSINATION – THE DAY AFTER. Bloomberg Online, Web.
CMA. Global Sovereign Credit Risk Report: 1st Quarter 2010. Web.
International Monetary Fund. IMF Staff Country Reports, 2010. [Online] International Monetary Fund. Web.
Iqbal, J.M., 2008. Pakistan Out of Default Risk. Derkeiler online, Web.
Joyner, J. 2008. Pakistan May Turn to IMF for Aid. Web.
Martin, M.F. & Kronstadt, K.A., 2009. Pakistan’s Capital Crisis: Implications for U.S. Policy. Web.
Nasir, M. 2010. Pakistan’s sovereign debt ranking improves. The Express Tribune, Web.
Qayum, K. & Sharif, F. 2009. Pakistan Sovereign Debt Rating Reduced to CCC by S&P (Update2).Bloomberg. Web.
Walayat, N. 2010. Global Sovereign Debt Default Bankruptcy Bailout and Contagion Risk Analysis. Web.