Pakistan May Need Debt Adjustment Despite IMF Bailout, Other Loans: Report

Pakistan may require a debt adjustment in some form given the sharp deterioration in its external position, even if some International Monetary Fund (IMF)/bilateral support materializes.

Barclays’ Credit Research report on Pakistan estimates recoveries in the mid-to-high 50s under various reprofiling scenarios and see them falling to the 40s if principal haircuts are involved.

Pakistan sovereign bonds have been pricing a high chance of a default/restructuring since September 2022, when Prime Minister Shehbaz Sharif noted the need for debt relief (moratorium from Paris Club members) in a Bloomberg interview. Since then, the sovereign’s bonds have traded in a range of 31-46 cents on the dollar.

Debt Outlook Vague, Reserve Drain Unstoppable Without Relief

• Debt profile skewed. Pakistan’s debt metrics in and of themselves are not yet a cause for alarm. But the outlook for the foreign currency debts is less clear, given the country’s inability to access to debt capital markets and weak balance of payment flows. The report sees foreign repayments at risk of a sudden disruption by any slowdown or delays in bilateral rollovers.
• Sustainability misjudged. Significant PKR depreciation without a commensurate change in Pakistan’s domestic markets will likely weaken further the country’s debt situation and debt sustainability, as depreciation has only a weak J-curve effect on its exports.
• Foreign currency flows in crisis. Pakistan’s balance of payments position indicates that the country is already in crisis. Given this, any financing secured from bilateral or multilateral sources will need to be deployed for debt repayments and to support letters of credit for imports. This implies that the drain of FX reserves is unlikely to halt in the absence of relief for debt repayments or incremental financing.
• Recovery estimates. In the event of a potential restructuring, the recovery values are likely to be in the mid-to-high 50s, assuming lower coupons and maturity extensions but no principal haircuts. In this outcome, IMF and bilateral funding/rollovers can be expected. However, if the country’s debt dynamics are worse than expected, then principal haircuts (at least 20 percent) will likely be needed, in which case the report estimates recoveries to be in the 40s, assuming 12-14 percent exit yields.

“Need to Adjust Debt” and Political Clarity Will be Key

Rebuilding foreign reserves is key for the government to restore investor confidence. The government is exploring foreign direct investments with China and the UAE. But with no access to capital markets, the country’s ability to secure loans or funding from bilateral and multilateral sources will be critical to arrest the drain of reserves.

In its base case, the report assigns a high probability to the “need to adjust debt” and believes political outcomes in the coming 3-4 months will be important drivers to predict the timing of the event. The type and size of available multilateral and bilateral funding will determine the type of restructuring needed; reprofiling or principal haircut.

While it is possible that the nation can avoid restructuring, there is a real risk that some form of reprofiling will become necessary. In such a case, the report suggests international bonds will play a key role.