Forex market turmoil and possibility of default

On 18th July 22, the country witnessed an unprecedented turmoil in the forex market. Dashing all expectations of stability on the eve IMF’s announcement of staff-level agreement on 13th July the exchange rate faced a near free fall after touching Rs 207 before long Eid holidays on 7th July it went up to 227 and some reports claim much higher figures not supported by official records. The following factors contributed to this turmoil:

First, on 16th July, the finance minister held a press conference where he disclosed that there was a continuing financing gap of $4 billion, which would be provided by the friendly countries. This was a surprising disclosure as normally one assumes that financing gap is bridged before a staff level agreement is reached. Second, the same day it was also revealed that IMF Board would meet near the end of August, which again was a big surprise as it clearly indicated that the tranche would not be forthcoming within the anticipated time of July.

Third, added to these two pieces of news the outcome of the by-elections in Punjab came the following day, which contributed to political uncertainty and affected market sentiments both in forex and stocks markets. In the next few days rupee lost nearly 10% of its value while stock market lost 3%.This trend of weakening rupee and losses in stocks market has since continued, though the latter recorded some gains last Friday. Another minister revealed that excessive stocks of POL were imported in the month of June, which led to a significant spike in the import bill which earlier had registered a shocking level of $80 billion.

Fourth, on 18 July, when the bloodbath took place, no functionary was available to calm the nerves of the market. Speculation and market manipulation are hard to disregard. Both SBP and finance minister issued assuring statements many hours after the market closure.

What happened in those and subsequent days is a result of weak oversight and lack of strong assertion of reviving stability since the new government came to office. Lately, this gap has been filled but not sufficient to quell continuing rumors and misgivings. Therefore, it is not surprising that market apprehensions regarding an imminent default gained traction.

In this article, we assert that Pakistan’s vulnerability to such an event has a very low probability. Before we give supportive arguments for our assertion, it would be useful to outline the key factors that impinge on a country’s external sector performance. At the outset, the most significant is the overall size of debt obligations and the share of external debt, both relative to the size of the economy. Second, given a level of indebtedness, how quickly this needs to be discharged. Third, what is the likely outcome of balance of payment (BoP) during the year and the likely movements in the financial account. It is the state of such indicators which should alleviate the apprehensions expressed by the markets.

First, the debt to GDP projected for FY2022 is 70% (though the final numbers are still in the making). We have taken total debt as Rs 47 trillion and GDP at Rs 67 trillion. This ratio is significantly low compared to many countries recently included in the Bloomberg report for possible defaulting countries. Most importantly Egypt’s ratio is 90%.

Second, the distribution of Pakistan debt across lenders and the length of time for repayment is quite unlike many other countries whose debt profile is much riskier. Of its debt of about $98 billion as on 30-6-2021, Pakistan owes $42 billion (43%) to multilaterals (IMF, World Bank, ADB, etc.), $31 billion (32%) to bilateral creditors, of which $11 billion is owed to Paris Club countries and $20 billion to other bilateral, of which China is the largest at $18 billion and the remainder to the UAE and KSA; Bonds and Sukuk are about $9 billion (9%) and commercial loans are $10 billion (10%) most of these are also from China.

The multilateral debts carry long maturities and low cost. Bilateral loans have same features. The real commercial credits are bonds and sukuk which are not due until end-December and next April. Other commercial credits are most owed to China, in fact 26% of overall debt is owed to China which has repeatedly proved its supportive credentials for Pakistan. Thus we it is evident that both the nature of our debt across lenders and timing of repayments are considerably favorable to Pakistan and pose no threat to our ability to make payments to our lenders.

Third, let us now review the balance of payments projections for the year. The finance minister has asked for an $8 billion reduction in imports from $80 billion in last fiscal year. In our view, this is still quite large. As a policy we should target CAD of not more than 1% of GDP, which would be $3.7 billion at an estimated GDP of 78 trillion and dollar exchange rate of Rs.210. This is imperative for stabilizing an overheated economy coupled with political turmoil. We maintain exports earnings and remittances to remain at the current levels, which would be heroic given predictions of global slowdown and possible recession.

These are estimates which call for policy choices consistent with the state of our economy and easily supportable by our resources. It would provide the country the necessary breathing space to put our house in order in fixing some of the most daunting challenges the economy is facing such as power sector debts, PSEs’ bleeding and sticky government expenditures, whose resolution would put the country on a stable path of growth in the long run.

Fourth, we are under an IMF programme and despite onerous conditions, Pakistan has succeeded in meeting them and earned a staff-level agreement. Although not to our liking, the Fund Board meeting is in the third week of August but it would approve Pakistan’s programme after its hard work.

Furthermore, the Acting Governor has issued a statement asserting that the financing available for the year was $36 billion against a need of $34 billion. One cannot ask anything more reassuring from a central bank governor, primarily charged with maintaining stability in country’s external payment system.

Weighing all the above factors it is reasonable to reach the conclusion that there is no imminent danger that the country faces where it would be unable to meet its external obligations. Yes, there is a disconcerting atmosphere in the market, basically triggered by political turmoil. However, this situation has no foundation in the fundamentals of the economy, and has been contributed largely by the missteps taken in the second half of the last fiscal year and which have since been corrected and their results would soon be evident.

Copyright Business Recorder, 2022