Pakistan: Can A Debt Crisis Be Avoided?
I am hard-pushed to think of many countries (except for extreme places like Zimbabwe, North Korea, the USA et al) that are facing such tremendous difficulties as Pakistan right now. As far as I can see, Pakistan seems to be on the brink of a debt crisis, and will have to secure foreign financing if it is to avoid default. Here are the reasons why:
• The rupee has plunged by about 23% against the US dollar this year. This increases the local cost of repaying external debt.
• Inflation is running at a 30-year high of 25.3% y-o-y, necessitating very high interest rates (13.0%), which are still negative in real terms.
• The current account deficit widened by 64% y-o-y in the first two months of the current fiscal year, and the trade gap continues to rise.
• Pakistan has one of the highest budget deficits in Asia, at around 7% of GDP. This means the government must continue to borrow heavily, either from at home or abroad.
• Pakistan’s central bank has only US$5.5bn of foreign currency reserves, compared with a government external debt burden of more than US$40bn (25% of GDP). The reserves are barely enough to cover two months of imports.
• The stock market has essentially been frozen by the authorities, who have imposed an artificial ‘floor’ that prevents it from going down any further. This is frustrating investors.
• Pakistan is one of the most dangerous places on earth in terms of security, as last weekend’s devastating Marriott Hotel bomb demonstrated. The new administration of President Asif Ali Zardari, like its predecessor, finds itself uncomfortably balancing pressure from the US to fight Islamic/Taliban militants in the Afghan border region and pressure from the Pakistani public to take a tougher line against the US, whose incursions into Pakistan have killed local civilians.
As a result of the above factors, Pakistan’s 5-year credit default swap (CDS) has widened to 1,500 basis points, the highest premium on a government CDS in the entire world – though it is still cheaper than several troubled US financial firms, such as General Motors (2,680bps), Washington Mutual (4,500bps), and American Airlines (2,193bps).
Pakistan's 5-Year CDS, basis points
President Zardari is in the US right now, where he hopes to smooth over bilateral differences – especially amid reports that Pakistani troops have fired on US helicopters and drones violating its airspace. Pakistan is reluctant to ask for financial assistance from the US and IMF, but it may have no choice if China and/or key allies in the Middle East fail to come to the rescue. I might add that given Pakistan’s geopolitical importance in the US’ ‘war on terror’, Washington would be unlikely not to arrange a bailout via the IMF. How strange for the US to bail out other countries and itself at the same time!