Defaults, past and present Situating current challenges
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By Raza Agha
akistan faces severe external financing challenges with rampant domestic political instability and higher rates in developed markets hitting capital inflows on the one side, while on the other rising commodity prices pump-up the import bill to unsustainable levels at a time when the country’s largest export markets in advanced economies are facing recession. As a result, SBP reserves have declined rapidly while Pakistan’s dollar needs - projected at $120bn or so over FY23 to FY26 by the IMF - have never been higher. Although the government has been trying to arrange external financing via the IMF and “friendly countries”, the intervening period has led to severe foreign exchange shortages in the market with the rupee falling to unprecedented levels in the interbank and the kerb premium rising sharply. Sadly, these challenges are not new to Pakistan. Throughout Pakistan’s 75 year history, repeated failures to mobilise domestic resources has created a growing need to borrow externally. And while Pakistan retained geopolitical significance - either due to the
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Cold War, the Soviet invasion of Afghanistan or in the post 9/11 world - the money kept rolling in. This relatively easy access to foreign capital allowed Pakistani policymakers to defer difficult but needed reform efforts. This luck has continued in recent years too. Post the 2007/08 global financial crisis, developed country central banks engaged in quantitative easing via a rapid expansion of their balance sheets, flushing the global financial system with liquidity. Facing negative rates in advanced economies, this abundant liquidity led to a surge in capital flows to emerging markets, including Pakistan, in a ‘search for yield’. 2022 marks the end of this policy experiment as central banks in advanced economies end quantitative easing and raise policy rates, rapidly given the impact of the Russia-Ukraine conflict on commodity prices. However, stop-go reform efforts and political instability means Pakistan is ill-prepared. This, unfortunately, is not new. Pakistan has had a long history with its creditors, wherein debt restructurings have been a regular feature in nearly every decade in the last 50 years. Other than Pakistan’s inability to maintain foreign exchange reserves or increase domestic revenue collection, previous debt
restructurings have followed periods of severe political instability (for eg, the late 1960s, and the late 1970s/early 80s), and/or exogenous unanticipated shocks (nuclear tests in 1998; Covid 19 in 2020). As we highlight below, current pressures are the result of similar endogenous and exogenous shocks that led to Pakistan to external liquidity challenges in the past: a poor reform effort under the previous administration’s 3.5 year stint in office, high levels of on-going political instability, changing geopolitical dynamics with the US’s exit from Afghanistan, high commodity prices and capital outflows from emerging markets due to monetary policy normalisation in advanced economies.
The first borrowings
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akistan first experienced difficulties with its external repayments long before the cessation of East Pakistan, which was generally viewed as the prelude to the first rescheduling in 1971. Consortium (OECD) countries were informed of payment difficulties in May 1968, 18 years after foreign assistance first started flowing to the country in 1950. Citing dwindling foreign
