Reforming Economy Under IMF Program Will Lower Pakistan’s Default Risk: Report

Pakistan’s strategy to handle the pandemic crisis, better level of foreign exchange earnings, and reforming the economy under the International Monetary Fund (IMF) program will most likely prevent it from going into default.

According to the report “Is Pakistan Closer to Sri Lanka – A Comparative Analysis” released by the Ministry of Economic Affairs, the government is cognizant of the default risk and initiated appropriate measures like taxing the wealthy, reducing subsidies, and re-adjusting the fuel, electricity, and gas prices to reduce the burden on the exchequer, it added.

The report noted that Sri Lanka defaulted on its debt obligations to its creditors in May 2022 when it failed to repay $78 million of debt interest even after availing of a 30-day grace period. The foreign exchange earnings of Sri Lanka reveal that the country experienced an overall 29 percent decrease in foreign exchange earnings in 2021 as compared to those in 2019.

This decrease occurred as a result of a substantial decline in tourism (86 percent), and remittances (18 percent). The foreign exchange reserves were recorded at $1.7 billion as of 30th June 2022 which included $1.5 billion in a swap facility provided by the People’s Bank of China. Consequently, the credit rating companies declared Sri Lanka as a defaulted country.

On the other side, the economic and political uncertainty in Pakistan is giving an impression globally that Pakistan might be following the footprints of Sri Lanka. However, due to relatively better economic management of the government, particularly during the pandemic and post-pandemic periods as well as during the prevailing global commodity crisis, Pakistan’s economy has shown a great level of resilience.

The economic situation seems to be in overall control in Pakistan as the foreign exchange earnings increased by 26 percent in 2021 as compared to those in 2019. The major increase was witnessed in remittances (35 percent) and foreign direct investment (10 percent). The total foreign exchange reserves of Pakistan stood at $15.5 billion as of 30th June 2022 and yearly debt servicing has remained around 2.5 percent of GDP during the last year.

Pakistan’s risk of default is low mainly due to the following reasons. First, Pakistan is already in the IMF program and on Monday received the Agency’s nod for a $1.17 billion tranche. Second, major multilateral and bilateral development partners have shown commitments to provide $8.7 billion during the current financial year.

It is also expected that Pakistan will be able to generate $14.1 billion from other sources such as the issuance of Bonds/Sukuk, foreign commercial borrowings, Naya Pakistan certificates, etc.

Thus, the total expected inflows for the fiscal year 2022-23 are $22.8 billion. Third, remittances from the Pakistani diaspora have always provided a sustainable cushion to meet external currency demands and have shown an increasing trend. Fourth, Pakistan has good economic relations with China, UAE, and Saudi Arabia. History has shown that in crisis situations, these countries have provided significant support.

The Central Debt of the government of Sri Lanka reached 104.6 percent of GDP in 2021 which stood at 78.5 percent in 2015. According to the Debt Sustainability Framework (DSF), if the gross external debt shows a significant or sustained breach of a threshold of 50 percent of GDP and the country is already facing difficulties in servicing its debt, then the country is said to be under debt distress.

In the case of Sri Lanka, the total external debt reached 60 percent of GDP in the third quarter of 2016 which kept on increasing further until 66 percent of GDP in 2019 but again reached 60 percent of GDP in 2021. The ratio of external debt to exports was 278 percent of GDP which also breached the threshold level of 240 percent.

The Debt Sustainability Framework (DSF) statistics in respect of Pakistan are relatively better than that of Sri Lanka. In May 2022, Sri Lanka failed to repay its debt payments due to a shortage of foreign exchange. The foreign exchange reserves declined substantially from $7.1 billion in July 2020 to $1.8 billion in April 2022.

In contrast, Pakistan’s level of foreign exchange reserves initially showed an increasing trend, from $20 billion in July 2020 to $27.1 billion in August 2021, and then started to decline and reached the level of $16.4 billion in April 2022.

Pakistan’s strong economic relations with China, UAE, and Saudi Arabia have always provided a cushion during hard times, however, with significant changes in the global as well as regional dynamics, it is high time to change thinking and policymaking approaches from assistance-seeking to a self-sustained economy for a better future. Quoting DSF, the Ministry noted some great similarities in both countries as well.

Pakistan is at high risk with respect to debt-to-GDP ratio, high risk at external debt stocks to exports, and high risk at debt service to exports.  Sri Lanka was at very high risk with respect to debt-to-GDP ratio, high risk at external debt stocks to exports, and high risk at debt service to exports.