Debt rescheduling challenge

The country is going through a very difficult balance of payment (BoP) situation. The core of the problem is growing external public debt and its repayment. A reduction in current account (C/A) deficit might not be enough to steer the economy out of it.

Interestingly, external public debt size–in percentage of GDP–is still significantly less than what it was in 1998-99. And the repayment capacity in relation to the SBP (State Bank of Pakistan) foreign exchange reserves is slightly better today as well.

Still the perception of crisis is identical, if not worse. There are two problems. One is the contractionary global financial conditions – increase in the US interest rates and rising dollar index. US Fed effective rates have increased from near zero in January 2022 to over 3 percent and will likely cross 4 percent by December. That has made Pakistan’s access to international debt market and commercial borrowing extremely challenging and costly.

The second problem is home grown: growing political uncertainty. That has made access to friendly countries’ bilateral debt difficult. The global issue is not under Pakistan’s control. The urgent need is to resolve political issues and move China and Middle Eastern countries and speak diplomatically to them about bilateral debt restructuring .

Having said that, the fear of default on commercial and capital market loans is overplayed. Out of today’s $100 billion public external public debt, $90 billion is multilateral, bilateral, and commercial creditors’ debt. Multilateral debt is concessionary and of long-term nature.

This fiscal year, the repayment in this head is at $3.9 billion. Similar, if not more, fresh loans are in the pipeline. The plan should be to repay the existing loans from fresh issuance.

The issue is of bilateral debt and commercial creditors. The repayment this fiscal year is $5.2 billion of bilateral debt and $6.3 billion of commercial creditors. These two are problematic. Commercial debt access to Pakistan is mainly from China and Middle Eastern banks and financial institutions, and the respective governments have a strong say in their decisions to lend to Pakistan – as either the banks are owned by government or work under its influence.

The third category is bonds and Sukuk which were raised from the global capital market. The talk about default in widely circulated growing secondary market yields is on these bonds. The repayment is $1.5 billion this year. This should not be an issue. However, fresh access is extremely difficult and costly due to the tight global financial conditions.

The multilateral debt cannot be restructured. The need is to talk with bilateral lenders – mainly China and the Middle East, with an aim to convert short-term loans and liabilities to long-term ones. There are benefits to bilateral debt restructuring. Had global conditions not been this bad, issuance of new bonds could have created some space. Country’s fundamentals are not that worse as are being portrayed by some.

A quick comparison between 1998-99 and 2021-22 augments the argument. There is no point of comparing absolute numbers as the economic size has substantially expanded since then. In terms of GDP, public external debt in FY99 was 52 percent of GDP as compared to 31 percent in FY22. In terms of SBP reserves, the external debt was 16 times in FY99 versus 13 times today. The issue is capacity to pay in terms of foreign exchange earnings – it was 23 percent in FY99, and the number shall be similar in FY23.

The point to emphasise here is that the size of debt is not the problem. The issue is short-term debt and rollover risk. Principal repayment will balloon over the next two years due to growing short-term loans and liabilities directly from friendly countries and their commercial creditors. The need is to alter the term of these loans to long term in order to calm the markets. Here, domestic political temperature is of utmost importance. That, however, does not militate against the need to improve the macro fundamentals. For that, the yardstick is the IMF (International Monetary Fund) programme.

Multilateral flows (especially the IMF and World Bank) are strictly connected to IMF reviews. In case of bilateral, there is no hard and fast rule, although they closely look at the IMF and make decisions accordingly. The political will matters more.

The need is to sit down and chart a revised plan,i.e., to restructure the debt. However, the question is who shall oversee the country and for how long? The political battlefield is getting ugly. The public support level of Establishment and the ruling coalition is incidentally lower than Imran Khan’s. That has made friendly countries confused. They are, therefore, pursuing a wait-and-see policy.

The state organs need to come on one page and talk to China and the Middle Eastern friends on restructuring the external debt. That cannot be strictly termed a default. And the country has restructured its bilateral loans thrice between 1999 to 2001. At that time, the Paris Club was the biggest lender – which is bilateral. First rescheduling was done in January 1999, second was in January 2000, and third was in December 2001 of $12.5 billion. And the country’s rating and economic health thereafter improved. This can well happen again.

Today, country’s bilateral debt is around $38 billion with the biggest lender being China by far at $23 billion (including Chinese commercial loans, the toll rises over $30 billion). Second in line is the Paris Club with $10.7 billion. Apart from these, there are commercial short-term loans and central bank liabilities- mainly from China and the Middle Eastern friends. The negotiations (or requests) this time are needed to be made with China and the Middle Eastern friends.

The US clout is largely with multilateral lenders. That is the biggest chunk - $42.5 billion. IMF’s direct loan is less than $8 billion. World Bank is the largest multilateral, followed by ADB (Asian Development Bank) and others. These loans cannot be rescheduled. And these are usually concessionary and long-term. The government can only try to get more loans from these to repay.

The real issue is of commercial creditors and bilateral. In both cases Chinese loans dominate. That is why the trip to China is of utmost importance. And without having China onboard, the country may not be able to come out of this difficult financial situation.

The question is why China or Gulf countries would come to our help. The establishment needs to think beyond the mantra of too big to fail. Pakistan no longer is as important on the global geopolitical stage as it once used to be. Pakistan has not even been mentioned in the US National Defense Strategy 2022. Pakistan’s issues are economic, and the country must seek economic solutions , rather than reverting to a geopolitical rent seeking mode.

No country would help Pakistan unless we tighten our belts. There is no change in public spending pattern. No fiscal measures have been taken to tighten the screws. The government is still not taxing the untaxed – real estate and traders, amongst others. The federal cabinet consists of 70-80 people. Some ministers are almost all the time on foreign trips. Their lifestyle is lavish.

In short, all stakeholders – politicians and establishment - care about their own self interests. How can others help to reform when Pakistan’s ruling class is not ready to reform its habits?

Copyright Business Recorder, 2022