June 23, 2023
ISLAMABAD – ON its present course, the country is set to run out of foreign exchange reserves latest by December of this year. The small surpluses registering on the current account in the past few months can, at best, postpone this date by a month or two, but they cannot avert it. And mind you, this is the best-case scenario.
It does not take complex economics to see this. All it takes is simple arithmetic. Pakistan has $4 billion in foreign exchange reserves and $4.7bn in debt service payments to make between July and December (assuming all rollovers go smoothly).
If we run a zero current account balance, meaning no inflows and no outflows of foreign exchange, then we hit zero foreign exchange reserves by or before December. The only way to avert this is to arrange a bailout of somewhere between $4bn to $5bn in the next few months.
In the past, it has taken a new government anywhere from six to 15 months to get onto a Fund programme. We don’t have an example in our history of a government getting onto a Fund programme within weeks or a few months after its swearing in. So the next government will have to make history in the speed with which it obtains accession to an IMF programme.
This assumes all will go as per the book. But if there is an early dissolution of the assemblies, maybe in July, followed by an ‘extended caretaker’ set-up, perhaps for a year if not longer, before elections are held, then the scenario can change.
The next government will have to make history in the speed with which it obtains accession to an IMF programme.
So the first hurdle to be crossed in order to avert a near inevitable default is to ensure there is a decision-making centre in the country. The present government seems to have lost the ability to clinch a deal with the IMF and unlock the inflows required to keep reserves from plummeting.
The next hurdle, after getting this new decision-making centre, whether as a newly elected government or an extended caretaker set-up, will have to pass one critical test in its application for a Fund programme. Thus far, all Debt Sustainability Analysis(DSA) reports put out by the IMF (the last one in September 2022) have classified Pakistan’s public debt as ‘sustainable’. But that could change.
If in the next Fund programme this assessment changes and Pakistan’s public debt is classified as ‘distressed’, it will trigger a new requirement to first get debt restructuring done before the programme can be presented to the Executive Board. This has been happening to more and more countries in recent years, though most are Low Income Countries (LICs) like Ghana, Zambia, Chad and Ethiopia.
But Pakistan was fine standing next to these countries when availing the benefits of the Debt Service Suspension Initiative back in 2020. Today, that same conversation about debt service suspension has turned into a conversation about debt restructuring under the Common Framework. A growing number of countries are finding that their debt levels no longer pass the stress tests in the IMF’s DSA framework, and one by one, they are all being sent into a gruelling process to restructure their obligations.
A recent note by JP Morgan said the bonds of 21 countries are trading at distressed levels. In Pakistan’s case, financial markets have already priced in a default given the prices that the country’s bonds are being traded at.
It is entirely possible that in the next approach to the IMF, the DSA finds Pakistan’s debt service obligations to be unsustainable as well, along with those of Zambia, Ghana, Chad, Ethiopia and many others, and sends the country off into a comprehensive restructuring process that involves Chinese as well as domestic debt.
It would be instructive to look at the experience of the four countries just mentioned when they set out to undertake their restructuring. Zambia defaulted shortly after the pandemic and is still wrangling with its creditors’ demands. Ghana appointed financial and legal advisers in the summer of 2022, and only this month managed to develop a set of proposals to send to its creditors.
Ecuador began its restructuring process shortly after the pandemic as well, gave it formal shape in February 2022, and reached a deal with the Chinese in September 2022. In short, in all these countries, the process has taken years, and in many cases, they are still far from a deal.
The IMF’s DSA has certain benchmarks for LICs to determine whether or not their debt is sustainable. One benchmark, for example, says a country’s debt-carrying burden is too high when its debt service-to-export ratio is above 21 per cent. In the case of Ghana, for instance, this benchmark was breached, and the staff-level agreement they reached with the IMF in December 2022 said it needed to be brought down to 15pc by 2028.
This required a restructuring exercise for Ghana that would shave off $10.5bn from its external debt service obligations in the three years running from 2023 till 2026. For Zambia, this ratio was closer to 25pc, and had to be brought down to 15pc over the programme period.
The same ratio in Pakistan today is above 37pc as per the Economic Survey. That’s where we are. This is why it is worth raising the matter of debt sustainability, and whether or not Pakistan’s debt levels will be seen as ‘sustainable’ in the next approach to the IMF.
Because if they are not, and Pakistan is sent into comprehensive debt restructuring before being eligible to draw fund resources, it could be a protracted process. And it is worth bearing in mind that the prime minister has at least two meetings with debt restructuring firms in the next few weeks, according to people familiar with his schedule. If debt restructuring is on the horizon, time will be even more of the essence than it already is.