In November 2020, as coronavirus ravaged economies, Zambia – a poor, landlocked African country – declared it could no longer pay interest to foreign creditors. The country instead diverted funds to run hospitals and put food on the table of its people.
Dozens of middle- and low-income countries are suffering under the burden of high foreign debt, which is straining their budgets and forcing them to cut expenditures on healthcare and education.
The United Nations and human rights groups have in recent months called for debt relief, urging creditors to reschedule and forego the dues of countries that are reeling from economic distress.
Activists who lobby for financial relief have long advocated for governments to default on burdensome debts if it comes down to a choice between feeding the poor or paying back rich countries, banks and hedge funds.
Pakistan, along with Egypt, Tunisia, Ghana and other nations, is facing a difficult situation where they borrow even more to pay off previous loans or engage with lenders to waive some of the debt.
Should Pakistan default like gusty Zambia?
“We are heading towards sovereign default for the reason that we don’t have money to repay our foreign loans, and we don’t have commitments for the payments of those loans,” says Shabbar Zaidi, former chief of FBR, Pakistan tax collection body.
Foreign exchange reserves of Pakistan’s central bank have dropped to $4.3 billion, sufficient enough to meet only a few weeks’ worth of imports. A $2.3 billion repayment is due to China next month.
Prime Minister Shehbaz Sharif’s government has put in place tough measures such as raising taxes on imports of iPhones, car parts and non-essential goods to stem the outward flow of foreign exchange.
But that’s not enough to ease the pressure.
In a recent report, credit rating agency Moody’s said Pakistan will likely default next month in the absence of a bailout from the International Monetary Fund (IMF).
A $1 billion IMF lifeline has been held up for months as Islamabad struggles with political upheaval amid a crackdown on former Prime Minister Imran Khan’s Pakistan Tehreek-e-Insaf party after May 9 protests that led to clashes between the protesters and law enforcement agencies.
The conflict in Ukraine, rising interest rates in the United States (which siphons off liquidity from capital markets) and post-pandemic impact on the global economy have made getting fresh loans expensive.
Over the next year, Pakistan has to come up with billions of dollars to pay its lenders even as exports and remittances sent home by expats - its two important sources of foreign exchange - lag behind.
Zaidi says Saudi Arabia and China have bailed out Pakistan by renewing credit lines as soon as the existing ones expire, which is akin to a default.
“Default has become a very sensitive word in Pakistan. We have made it a matter of ego. But in a real sense, when you are not able to pay your debts in time, and you reschedule your debts, or you actually borrow new loans to repay the previous ones, then it is, in an indirect sense, our default.”
Last year, Sri Lanka suspended payments on its foreign debt after its economy tanked.
Pakistan must make a case for itself, telling the international community that paying back is not possible and taking in more loans is expensive, says Zaidi.
“Heaven will not fall if Pakistan reschedules.”
The credit market has already braced itself for Pakistan’s probable default.
The bonds, which Pakistan has issued to borrow from private creditors, are already trading at steep discounts.
“Default on sovereign US dollar bonds is already priced in by investors and will not be a shock,” says Hasnain Malik, head of equity research at London-based Tellimer.
“That doesn’t make the default any less painful for Pakistan, with lasting repercussions for its cost of external borrowing. Still, the more orderly the default and the quicker the path to corrective economic policies the better,” he tells TRT World.
Tough road ahead
As evident in the Zambia case, negotiations with creditors are not easy, especially when they involve private lenders.
Creditors want the indebted country to lay out a repayment plan under the supervision of the IMF, which plays the role of a guarantor, ensuring the troubled country puts its finances in order.
Rescheduling can involve extending the duration of repayments and a haircut, where lenders agree to reduce the amount of principal and interest.
Even though Zambia and the IMF have agreed to a standby arrangement, private creditors are dragging their feet. China, which is the single-largest creditor to the African country, wants Western banks and multilateral lenders to foot the bill before Beijing agrees to play its part.
Most of Pakistan’s debt, more than 80 percent, comes from the World Bank, Asian Development Bank, Paris Club members, China and Saudi Arabia. These non-commercial multilateral and bilateral lenders are easier to deal with than private creditors.
But this hasn’t stopped the drain on its foreign exchange reserves. Between 2019 and 2021, Islamabad paid $28.7 billion in debt servicing, according to the finance ministry.
Islamabad has a good shot at asking for a reduction in debt burden by negotiating with its major bilateral creditors such as China and Saudi Arabia, key allies of Pakistan, says Tahir Abbas, head of research at Karachi-based brokerage Arif Habib Securities.
“But we have to give them a plan and assure them that we would repay the remaining debt.”
However, exports, foreign direct investments and remittances - all sources of foreign exchange - can not be increased fast enough to settle the tens of billions of dollars in liabilities.
Talking to creditors also needs political stability, which Pakistan is lacking at the moment. That’s one of the reasons the IMF loan is getting delayed, experts say.
While foreign debt is the immediate concern for policymakers, another financial crisis stems from within Pakistan’s own borders.
Around 63 percent of Pakistan’s total public debt is domestic, which means the government owes that money to local commercial banks.
Islamabad has printed money at a breakneck speed for a few years to pay off domestic debt and, in the process, pushed inflation to a record high.
For the banks, which pay meagre interest to depositors, it was profitable and safe to invest in government securities, which earned a higher return.
“All top banks are booking profits courtesy of arbitrage they are making on government money by collecting at zero interest rate from the public, cheap borrowing from the central bank and lending it back to the government at higher rates,” says Saad Bin Ahmed, the managing director of KTrade Securities.
Any rescheduling of debt means Pakistan domestic banks would also have to take some haircuts.
“This is why commercial banks are now facing a sovereign default risk,” Ahmed.