Pakistan facing acute solvency crisis

6 September 2008 by Abdul Khaliq

Pakistan’s sovereign debt Sovereign debt Government debts or debts guaranteed by the government. is going to be the riskiest. For the week ending Aug 29 2008, Government of Pakistan bonds overtook Argentina’s to be the unsafe for investment, say London financial market Financial market The market for long-term capital. It comprises a primary market, where new issues are sold, and a secondary market, where existing securities are traded. Aside from the regulated markets, there are over-the-counter markets which are not required to meet minimum conditions. indicators.

In London, where Credit Default Swaps CDS
Credit Default Swaps
Credit Default Swaps are an insurance that a financial company may purchase to protect itself against non payments.
(CDS) are traded, the price for insuring $10 million worth of Argentina’s debt stood at $788,000 while the price to insure the Government of Pakistan-guaranteed debt skyrocketed to $950,000 — something that has never happened before — Pakistan’s debt is now the priciest to insure (read: the London market is contemplating a default-like scenario).

Pakistan’s total foreign debt and liabilities Liabilities The part of the balance-sheet that comprises the resources available to a company (equity provided by the partners, provisions for risks and charges, debts). have now crossed the $45 billion mark. A recent report by Citibank, “Pakistan: Could the Political Chaos Lead to Sovereign Default?’ asserts, “if Pakistan opted to default, it would have to reschedule all of its debts, which amounts to $2.6 billion in self-issued bonds and $13.9 billion in bilateral debt”.

Pakistan is teetering on the brink of default, the report further claims. Since the taking over by new government Pak rupee has lost some 23 per cent of its value over the past quarter. The report urges that Pakistan cannot do without the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
, the Asian Development Bank (ADB), the Islamic Development Bank and another Saudi oil facility.

The appalling economic situation has forced the country to actively consider the option of withdrawing over $2 billion foreign currency reserves parked in US Treasury and its capital market. During the previous regime of Gen. Musharraf, the government hired fund managers for management of the reserves, who parked money in capital markets, bonds as well as US Treasury.

The foreign exchange reserves are depleting rapidly in the range of $250 to $330 million weekly. As total reserves held by the central bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

now stand at just $4 billion, which can fulfill requirements of one month of imports, the situation has put Pakistan in the ‘danger zone’ regarding its external obligations. In case of non-availability of Saudi oil facility worth $5 to $6 billion, Pakistan may face the threat of default.

Unskilled handling of foreign reserves is quite apparent as Pakistan is getting a meager 1 to 1.5 per cent return on its parked money in US Treasury while on the other side it has floated eurobonds on which it is paying a much higher rate in the range of 7 to 10 per cent. “Pakistan is a net loser in this forex game,”

On the internal front, things are even more critical. By the end of August 08, inter-corporate circular debt had soared to a colossal Rs.400 billion. Most of this amount comprises arrears of different power producing companies. The government owes oil-marketing companies Rs.84 billion on account of Price Differential Claims (PDC).

The Pakistan Electric Power Company (Pepco) is owed Rs. 150 billion. The Federally Administered Tribal Areas (Fata) owe Pepco Rs.75 billion. The Karachi Electric Supply Company (KESC) is holding back the payment of Rs.56 billion. Several Independent Power Producers (IPPs) have threatened to encash the government guarantees Guarantees Acts that provide a creditor with security in complement to the debtor’s commitment. A distinction is made between real guarantees (lien, pledge, mortgage, prior charge) and personal guarantees (surety, aval, letter of intent, independent guarantee). .

Hubco (1,200 MW), Kapco (1,600 MW) and Uch (586 MW) have stopped power production because of stuck payments with the government. Hubco and Uch, producing 1,786 MW, have put the government on a 30-day notice to pay their arrears of Rs.66 billion or they would turn their plants off. It economic indicators show Pakistan, is facing an acute solvency crisis.

As a result of above-mentioned facts there is severe power shortage in the country. Under power load management people have to face 10-to 16 hours electricity shedding daily. The energy crisis coupled with recent political crisis has made economic activity much slow in the country.
Like other countries of the South, debt has become a core issue and straightjacket for Pakistan. The World Bank World Bank
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

has been lending to Pakistan since 1952. During this span of 56 years it has sanctioned over 100 loans and 145 credits. The World Bank’s highest borrowers are also the most corrupt according to Transparency International Index. Pakistan is a favorite debtor country of the World Bank (among the top 12).

There has been severe lack of effective use of WB and other creditors money by the ruling clique in Pakistan. Squandering of funds on projects was in the interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. of the ruling elite, as the interested parties used or deposited a large portion of these funds in their personal accounts.
According to international law this is responsibility of the creditor to ensure that given funds should be spent for the specific purpose. But in case of World Bank it did not fulfill its responsibility and let the ruling classes of Pakistan plundered the funds. This money was meant for the uplift of the poor people and the economy, but instead it was embezzled and misappropriated by different governments in the country. As a matter of fact the Pakistan’s WB debt is illegitimate.

Pakistan’s ever increasing debt burden and the cost of servicing this debt is perhaps the single most important economic issue in the country today. Economic policies of the governments have failed completely to fill the gap in the trade balance Trade balance The trade balance of a country is the difference between merchandize sold (exports) and merchandize bought (imports). The resulting trade balance either shows a deficit or is in credit. , balance of payments Balance of payments A country’s balance of current payments is the result of its commercial transactions (i.e. imported and exported goods and services) and its financial exchanges with foreign countries. The balance of payments is a measure of the financial position of a country vis-à-vis the rest of the world. A country with a surplus in its current payments is a lending country for the rest of the world. On the other hand, if a country’s balance is in the red, that country will have to turn to the international lenders to meet its funding needs. , budget deficit, or resource gap over the many decades. Poverty has grown in the country during the last ten years.

Historically speaking, in the 1950’s and the 1960’s approximately 70 percent of the Pakistan’s foreign aid package was non-returnable grants and only approximately 30 percent were loans and credits. Of this, about 80 percent were spent on development expenditures and only 20 per cent were spent on non-development purposes.

Somewhere in the 1980’s and the 1990’s the situation had reversed. Approximately 80 per cent of the foreign aid package for Pakistan was being spent on armed forces and other non-development expenditures; almost all of the foreign resources for the country were in the form of loans, credits and direct investments at quite harsh conditionalities and heavy interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
. In the 1990’s and the year 2000 all of the foreign assistance has been spent on debt servicing. At the cost as high as in Pakistan, foreign aid has become a burden, rather than a blessing.

On account of creditors bad intentions, poor economic policies, and misappropriation of funds by ruling elite, Pakistan could not benefit from international lending. The purpose of funding never ever fulfilled. As a result Pakistan today is ranking at bottom with regard to social indicators.

Today we are among the most illiterate countries of the world; school going children are out of school and working on road side workshops or restaurants; women participation in economic growth and decision making is very low. Child mortality rate as well as women mortality in childbirth is one of the highest in the world. General health conditions of the population are very poor, so is the income generating capacity of a large number of the population.

In this backdrop the ever-increasing national debt and poor economic policies are a perfect recipe of disaster for the country’s future, which seems unsustainable under the circumstances.

Abdul Khaliq

CADTM Pakistan

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