The multi-coloured balloon has just taken off. All the people are watching this spectacular sight with awe. After a while, this balloon bursts into different patches.
The above-mentioned situation applies to the economic health of our country. New incumbent governments try to exaggerate the economic indicators, but this short-term relief evaporates in thin air.
We have time and again faced this stark reality. But this time, the only thing exceptional is the highly flown idea about the default risk of Pakistan. We are on the brink of economic collapse due to various economic, administrative, and political blunders. However, the chances of the default risk of Pakistan are very thin.
The timely IMF agreement and the resultant aid flowing have saved us from this doomsday
What is Default Risk?
As per Investopedia, default risk is a situation when a country fails to repay its debt obligations on time due to various factors. Secondly, the government of a defaulted economy announces that it is not in a condition to fulfil its debt obligations. The defaulted economy cannot pay the amount on its matured bond. As a result, it cannot receive further debt and LCs. Due to this, all its external transactions are hampered.
What Happens When a Country Defaults?
The defaulted economy cannot receive further debts, aid, or letters of credit. It cannot import machinery and the raw materials necessary to run the wheel of industries. As a result, a lot of people lose their jobs. Similarly, we cannot import edible oil and crude oil, which deeply impacts our food chain and electricity production. The agricultural sector and defense portfolios are highly affected. The defaulted country runs out of dollars, and its external transaction portfolio slides.
No country will be ready to export its items to that economy. In the same way,. Its financial aid and debt portfolio are temporarily suspended.
Has Pakistan Ever Defaulted?
Last-minute emergency loans have prevented Pakistan from defaulting. Pakistan’s dependence on foreign loans has put it in a debt trap.
Pakistan received a loan portfolio of 110 million dollars from 1951 to 1955. The figure tripled in the next few years due to the role of Pakistan in the Cold War. After the exit of the Red Army from Afghanistan, the new drama uncovered was the war on terror. A large chunk of money flowed as Pakistan was declared a non-NATO ally and a frontline state in the war on terror.
After the war ended, the reserves of Pakistan started to evaporate. It came to the brink of bankruptcy in 2013. But here comes the IMF which bails out short loans with higher interest to the countries that are in the top slot on the graph of default risk of Pakistan.
Pakistan is entering into the IMF programme for the 23rd time. It is going to have its ninth review. This makes the economy of Pakistan an economy that has borrowed growth since independence. The other major creditors of Pakistan include the USA, Saudi Arabia, the UK, the UAE, China, Kuwait, Canada, and France. They have made the options of deferred payments and debt rescheduling available. In the past, timely aid and payments from IFIs and friendly countries have mitigated the scenario of default.
Default Risk Of Pakistan Percentage
As far as the percentage of default risk of Pakistan is concerned, different clichés have become the talk of the day. It has been claimed by different media sections and politicians that Pakistan is on the verge of collapse. This is due to the CDS, which is being propagated near crossing the mark of 100 plus.
Default Risk of Pakistan Graph
Following is the recent graph of default risk of Pakistan by the Bloomberg Institute:
Decoding CDS
Actually, a credit default swap, or CDS, is one of the derivations or contracts of international financial markets and capital markets. Any financial institution presents put-options and buy-options in the trading market. When a loan portfolio is announced between a lender and a borrower, it facilitates the process. For example, person A allocates a loan portfolio of 100 billion dollars to person B. Person A will have to reach an agreement with Company C in which B works.
The agreement states that if B is not in a condition to return the loan, C will compensate for this. While A will have to pay a fixed amount to Company C for a fixed period of time,. You can say that CDS is insurance against default.
The default risk of Pakistan through the prism of CDS
The CDS of Pakistan do not have much value or are not traded in the international market. So, it is not a reliable instrument in the case of Pakistan. We will have to understand it in terms of the due payments to Pakistan. Last year, Pakistan paid its 1 billion dollars due when its bond matured in December, even before the stipulated time. Now Pakistan does not have to make a big payment until April 2024. So the chances of default are thin at the present moment.
Factors Pushing the Economy to the Brink of Default
As the reserves of Pakistan are dwindling fast, the Damocles sword remains in place.
As per IFIs, the reserves of a country should be enough to cover the import bills for at least three months. As per SBP data, these reserves were, at the time, 3.6 billion dollars. These are not enough to cover the one-month payments.
Delayed IMF Negotiations And Insufficient Portfolio
The current setup delayed its talks with the IMF, which should have been completed last October. Now the mission is in Pakistan to review the stipulated actions and claims, after which it will bail out. It will bail out 7 billion dollars. This amount will dry out after June, which will lead to difficult times again.
Time-Tested Countries Not Doling Out the Required Amount
Recently, trusted partners even like KSA, China, the UAE, and the USA decided to delay the portfolio until an IMF agreement is reached or economic reforms are carved out. This has put economic health in a fragile condition.
Revenues Not Up to the Mark
This year, Pakistan is short a $300 billion in petroleum development levy. Further, the circular debt and energy crises have aggravated the situation. The Letter of Credit is not being given to the export-oriented industries, which has put the industrial sector under strain, and 2 crore people are out of a job. all the ventures significantly contribute to increasing the default risk of Pakistan
A Diary of Default
Let’s take a look at the number of times Pakistan has come close to defaulting this year
What will happen if Pakistan Defaults?
God forbid, if Pakistan defaults, its imports will be stalled and letters of credit will not be issued due to the scarcity of dollars. We import edible oil for our food consumption. Our food chains will be severely disrupted. We import crude oil for our energy requirements.
It means that the wheel of the economy will be blocked. The machinery necessary for our agricultural and industrial sectors will not be imported, thus the collapse of relevant sectors would be apparent. A lot of people will be rendered unemployed. The scarcity of commodities would sour the levels of inflation up to 70% and increase the default risk of Pakistan.
How Can Pakistan Minimize its Default Risk?
The following are the pragmatic measures needed to pull Pakistan out of this quagmire of default risk of Pakistan:
1. Sustained and Pragmatic Aversion of Default Risk of Pakistan Through IMF
The leadership should make it of prime importance that Pakistan gets maximum leverage from the IMF’s portfolio. The leadership should ensure that the IMF extends its program to June when the economic conditions will be more critical.
2. Widening of Tax Net and Progressive Taxation
The authorities should widen the tax net. It is a very sad reality that Pakistan has a tax-to-GDP ratio of only 8%, while all over the world, a healthy tax ratio is 13%.
The agricultural and real estate sectors are out of the tax net. The real estate sector of Pakistan enjoys a casino economy. While big landlords enjoy tax exemptions due to their political capital,. These sectors needed to be reined in. The elites of Pakistan should be dealt an iron hand with their taxes.
3. Targeted Subsidies and Transfers
The government should incentivize and give targeted subsidies to export-oriented industries. So they may innovate and add new features to make our exports competitive. The taxes collected from the elites or the money saved through austerity can be transferred to the poor to cushion them against soaring inflation.
4. Installment of A Robust Local Government System
In Pakistan, democracy has failed to deliver because the powers are concentrated at the federal and provincial levels. A strong local government system will collect more revenue that will be sufficient to meet the expenses of a province. As a result, the federal government will have more cash in its pool to spend. It will cushion our economy against a severe fiscal deficit.
5. Free Floating Currency Value
The government should give up its habit of controlling currency artificially. Let market conditions decide the value of your currency. It will enhance our exports and minimize our current account deficit.
6. Privatization and Institutional Reforms
State-owned enterprises which are notoriously known as loss-making entities, should be privatized. Though it involves several risks, we will have to turn to this for sustained economic reforms. Institutional subsidies should be provided to only those who show expected performance.
7. Increasing the General Prices For the Longer Effect
Through proper platforms, the masses should be sensitized against the rising inflation that will result as a result of petroleum and energy prices rising. The rulers and, if possible, elites should bear this cost to show harmony with the general masses.
Wrapping Up
To sum up, we may deduce that conspiracies are being hatched to destabilize the economy for the vested interests of certain sections. Those who are behind these nefarious designs should know that they are burning their own bridges.
Although the ship of our economy seems to be stagnant, through good political will and general concerted efforts, we will be able to show our resolve to the world community about how we are going to turn the tide in our favor. But it is easier said than done. Let’s hope for the better.