Managing sovereign default

Nations can and do periodically default on their sovereign debt, despite the fact that they do so comparatively infrequently. This happens when a country’s government is either unable or unwilling to repay creditors.

Among the nations that have recently defaulted on their debt are Argentina, Lebanon, and Ukraine. Pertinacious economic stagnation sabotages a country’s ability to service its debt and leaves its economy more vulnerable to shocks such as a recession or a pandemic.

It also crumbles the confidence of foreign and domestic creditors, making it more difficult and costly to refinance debt. According to Moody’s, chronic quiescence was the fundamental cause of sovereign debt defaults by Russia and Ukraine in 1998, Argentina in 2001, and Venezuela in 2017.

High debt accumulated amid trade and budget deficits can also make the repayment burden unviable. Examples include Greece in 2012 and Lebanon in 2020.

Moreover, political instability and financial mismanagement have become increasingly likely causes of sovereign default. They were the primary factor in defaults by Argentina in 2014 and 2019, Ukraine in 2015, and Ecuador in 2008 and 2020.

In enfeebled economies, a small political shake-up can disturb a country’s entire development process, slowing down the pace of economic activity, creating a sense of insecurity in the financial sector, and diverting the nation’s progress toward economic security. All of this can result in another set of problems.

This is exactly what happened in Pakistan when the coalition government came into power corridors. The coalition government faces mountainous issues: skyrocketing inflation, massive devaluation of the Pakistani rupee against major world currencies, increasing fuel prices, and the drying up of foreign currency reserves.

Surrounding all of these challenges is the fear of a debt default. Default on sovereign debt is a difficult situation for any country and its donors, but it is very much part of the global economic system, and there have been some countries that have defaulted on sovereign debt in recent years, as mentioned above.

In Pakistan, however, it has been politicized and raised to such a level of concern and debate that it sounds like the Holocaust. According to recent data from the State Bank of Pakistan, Pakistan has net reserves of $8.8 billion, commercial bank reserves of $5.67 billion, CAD for FY21-FY22 of $44.71 billion, and CAD for July 22 of $3.35 billion.

In July 2022, national Consumer Price Index inflation increased to 24.9% (from 21.3% in the previous month). So far this year, GDP has grown at a rate of 5.97% (against a target for 2022–2023 of 5%). Now, if we were to ask whether our country was about to default, we would say no for the following reasons:

Firstly, much of Pakistan’s political history consists of decisions that were made without contemplating the economic consequences. Furthermore, many previous governments were unable to succeed in the economic domain because they lacked an adequate and top-tier team of economists capable of developing long-term economic policies.

Whereas, due to the significant political cost and the upcoming elections, the current government will use all available means to prevent such a situation. The unrelieved economic problems have been caused by inconsistent economic policies, the pursuit of the wrong priorities, and bad governance. This is why Pakistan has not materially developed over the last 75 years.

Fiscal policies have also led to deficit consistency as successive governments changed policies to prioritize certain sectors, resulting in precarious economic conditions. Secondly, Pakistan’s international partners 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 rather bet on it than a default and losing repayments, albeit for some years. Having said that, it is neither a time to be complacent nor is such a situation favorable. A patient in a coma or in the ICU is more of a concern than any other situation.

Due to the aforementioned reasons, Pakistan’s default on its sovereign debt may be avoided or delayed in the current year, i.e., 2023. Given the economic issues confronting emerging nations such as Pakistan, effective and sustainable policy making and change can only be achieved through competent data analysis.

Policymakers need to identify the reasons why the economy of Pakistan is not expanding at the appropriate growth rate and create a comprehensive development strategy to execute sustainable growth free from political interference.

Pakistan needs political stability at the same time. Political unrest sabotages economic growth and fosters poor governance, which finally seizes control of all civic institutions and leads to recurrent financial crises.

Copyright Business Recorder, 2023