Shape up or ship out!

For the past few months, there has been significant concern and consternation over the possibility of a Pakistani “default,” which has been extensively covered in both local and international media.

Given the bone-tired economy, the fiscal situation, scampering inflation, and the depreciation of the Pakistan rupee, all signs point towards a wounded government, which has arrived at a point where it no longer enjoys any functional depth.

In real terms, it is not in a position to provide relief to people because all options have been impoverished. Even if the IMF (International Monetary Fund) program is restored, most economists believe it would take years for the country’s economy to stand up.

To determine whether or not we will default, it is crucial to understand the foundations of a situation similar to default and the state of the nation’s economy.

Deconstructing the complicated terminology of sovereign default and default risk in its totality is essential.

Due to Sri Lanka’s default on its sovereign debt, Pakistan’s predicament has been compared to Sri Lanka’s in people’s minds. The economic collapse of Sri Lanka is a completely unrelated event and should not be compared to Pakistan.

Delay in the ninth review of Pakistan’s economy by the International Monetary Fund (IMF), which partially blocked foreign currency flows into the country as the country’s debt-to-GDP ratio is in the danger zone of 70% and between 40% and 50% of government revenues are set aside for interest payments this year.

On the other hand, Pakistan’s total external debt and liabilities have increased to $127 billion (41% of GDP) while sovereign bonds have lost more than 60% of their value. Moreover, exports and foreign direct investment, too, are not brightening the gloomy picture.

According to the most recent IMF country report, Pakistan has external debt service obligations of $73 billion over three years (FY23–FY25), compared to current foreign exchange reserves of $4–5 billion. The absurdity is that Pakistan’s ruling class still refuses to acknowledge the seriousness of the situation and is unwilling to give up the privileges it has benefited from for years.

It is once again decided to put the cost on the working class rather than reduce needless benefits. The nation is drowning, but its debt-dependent ruling class believes it will survive these trying times because the rest of the world cannot afford to see it do so. But this time, it seems that the world won’t step in to save Pakistan until and unless its ruling class is prepared to do so.

Yet a few days ago, Pakistan made a $1 billion payment on a maturing Sukuk (shariah-compliant) bond, which soothed fears and reduced tension. But in reality, this has already been greatly exaggerated; therefore, it’s critical to comprehend the initial assumptions that led to the “default” claim.

In essence, CDS is an insurance policy that offers the investor financial security in the event of a probable government default.

Every time a bondholder or investor makes an investment in Pakistan, they often buy a CDS from an investment bank, which offers cash compensation in exchange for a premium.

The CDS for Pakistan is apparently problematic for three reasons. First, in international markets, mood is crucial, and it is largely negative at the moment. Our ministers are passing comments that were reported by social and press media in which they claimed that Pakistan is not defaulting but has already defaulted and that we are living in a bankrupt country.

These ministers are ignorant and have no knowledge of the fundamentals of the economy. It causes investors to be more cautious and risk-averse when buying CDS as insurance.

Sentiment has been damaged by recent instances of economic unrest in nations like Sri Lanka and Lebanon, and the most alarming signs point to an impending worldwide recession in 2023.

Also, as US interest rates rise, capital is migrating out of developing country bonds, which causes them to decline as well as investors avoiding this asset class and raising insurance costs generally.

Also, a larger CDS percentage means that the investor would have to pay a hefty premium to the investment bank rather than reflecting the country’s propensity to default. Thus, there is no correlation between sovereign default and CDS.

Third, because to Pakistan’s large emissions and infrequent trading in comparison to other nations and businesses, the CDS for its sovereign issue is not highly liquid.

An illiquid market is often highly inclined to inaccurate price signals, and one cannot therefore get an informed picture of the real risk in the market’s view. With these considerations in mind, predictions of an impending “default” with a shape in or ship out approach should always be taken with a grain of salt, especially if they are based on shaky foundations.

The second-largest source of income after exports is remittances, however they are in decline.

The interbank exchange rate is consistently around 278 while the open-market rate is skyrocketing, indicating a growing grey market, while reserves are steadily dwindling. Reviving our IMF programme must be our top priority.

The simplest way to ease these concerns about CDS is, of course, to establish a solid economic foundation first. Even such rumors are readily debunked in prosperous economies.

Copyright Business Recorder, 2023