Is Pakistan far away from default?

Pakistan would not default on its international obligations despite the economy being in a “tight situation.” Pakistan’s economy is facing a severe balance of payment crisis. Central bank reserves have fallen to barely enough for a month of imports. But speaking at an event via video link at the Pakistan Stock Exchange, the finance minister said the government had arranged $31 billion required to get through fiscal year 2023.

Firstly, the current government would deploy all possible resources and efforts to avoid such an eventuality due to a heavy political cost, particularly in the context of forthcoming elections. Secondly, the international partners of Pakistan would not like such a situation due to the potential negative implications for internal and external security. Thirdly, the multilateral and bilateral donors are still hopeful for an economic recovery in Pakistan and would bet upon it rather than a default and losing repayments, albeit for some years. “We are once again stuck in tight economic situation,” Dar said. “We are a resilient nation and we would survive the ongoing crisis and return to progressing path.” Dar also discussed the issue of currency exchange rate disparity, blaming it on the smuggling of dollars to a neighboring country, in a veiled reference to Afghanistan: “The law enforcement agencies are working to stop the smuggling of currency and we hope that this issue would be resolved”. With the IMF’s ninth review pending since September, Pakistan has desperately been scrambling to secure financing to meet external payment obligations for the current financial year. Ahead of the review, Pakistan has been trying to approach allies to seek financial support, and Dar has said earlier that he would expect to get $3 billion from a “friendly country”.

Default on sovereign debt is a difficult situation for any country and donors, but it is very much part of the global economic system, and there has been some countries which defaulted on sovereign debts in recent years. Any common citizen would ask what can we do to avoid default, and the easiest and the most accurate response would be to stop taking further loans and generate revenue to meet current expenditure and forthcoming repayments of external and internal debt. Unfortunately, such an easy response is the most difficult governance issue in Pakistan. A single-digit tax-to-GDP ratio, with more than 60% of revenue generated through indirect taxes and GDP in excess of $300 billion, is the real point of concern, not the rounds of negotiations with the IMF. It may even sound redundant to say that we need to expand the tax and revenue base rather than the incidence and rates on current taxpayers. Progress over policy measures includes strengthening fiscal position; reducing untargeted subsidies; scaling up social protection; helping the most vulnerable; making exchange rate market-determined, enhancing energy provisions; preventing further accumulation of circular debt; and seeking financial support from external partners. It has been mentioned that Pakistan needs improvement in its sustainable development as well. There has been a considerable progress in the negotiations with IMF and Pakistan hopefully will get a $1.1 billion tranche under the $6.5 billion bailout package awarded in 2019. Also, since most of Pakistan’s debts are bilateral or multilateral, they can be rescheduled; and commercial loan repayments are not too much to lead the country towards a default as was the case with Sri Lanka.

Here, it is important to understand the nature of debts and loans. When the revenue generated by a government does not cover its expenditures then governments in developing countries in particular obtain loan from other governments, states, multilateral financial institutions, commercial banks and private capital markets for developing infrastructure, supporting foreign exchange reserves, etc. Such loan payments are made with sovereign guarantees to the lender to repay with a certain interest rate and terms and conditions. The default on repayment is more about a state not willing to pay, instead of a state not being able to pay. When a country declares default, it actually declares its inability or unwillingness to make repayments. This decreases the credit rating of that country to get further loans. While a state not having the capacity, but willingness to make repayments, is able to get its loan rescheduled. Furthermore, the strategic factor cannot be ignored. Pakistan is located in the neighborhood of the world’s fastest growing economy, China. Pakistan is also a gateway for global trade through central Asia. Pakistan is the 5th most populated country of the world and is a nuclear power. International players still need Pakistan’s support due to its strategic location. Hence the international community friendly countries in particular are unlikely to let down Pakistan. However, it must be noted here that Pakistan is in a classical debt trap and needs effective economic reforms and policies to come out of it. Pakistan needs to promote its local industry to cut down on its imports and be self-sufficient, leading to an increase in exports. In the light of above factors, the likelihood of Pakistan defaulting on its foreign obligations is very low. However, it must be noted here that Pakistan is in a classical debt trap and needs effective economic reforms and policies to come out of it. Pakistan needs to promote its local industry to cut down on its imports and be self-sufficient, leading to an increase in exports.