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Tuesday, March 28, 2023

Risk of default and Macro-economic instability in Pakistan

By Danial Arshad

Foreign exchange reserves are important for every nation because they include bonds, deposits, banknotes, treasury bills, gold, and other government securities. They can ensure that the central government agency has backup funds to support the national currency if it devalues at some point. A Country becomes insolvent when it is temporarily unable to make principal and interest payments because its asset base cannot be liquidated quickly. The importance of foreign exchange reserves for developing countries is based on the security of home currency positions, economic growth boost, maintaining liquidity in economic crisis, attracting foreign investments, funding infrastructure projects, etc. The most immediate effect of a sovereign default is to increase borrowing costs of Government in the domestic and international bond markets.

Pakistan default risk has risen sharply to 79.33%. Following the current political turmoil and uncertainty over the 9th review of the international Monetary Fund’s (IMF) bailout package, statistics released by Arif Habib Limited show that the country’s five-year credit defaults swaps (CDS) rose from 7550 basis points (bps) to 7933 basis points (bps). Perceived default risk was 7% in year bps. Finance Minister Ishaq Dar and many financial experts have reiterated that Pakistan has not defaulted on any if its international payments and CDS volatility has nothing to do with the country’s default risk. The risk of Pakistan’s debt default is heightened by several factors, including the delay of the IMF’s 9th review, declining FX reserves and political unrest. This is definitely a worrying sign for our economy. Sovereign debt defaults are relatively rare, but a country can default on its sovereign debt. This happens when a country’s government is unable or unwilling to repay its creditors. Argentina, Lebanon, Ukraine and Sri Lanka are among the countries that defaulted in recent years. Look at some countries having World’s highest Foreign reserves and also with zero reserves like Sri Lanka.

Sr.No Name of the Country Foreign Reserve (USD) bn
1 China 3289.9 USD bn
2 Japan 1226.3 USD bn
3 Switzerland 885 USD bn
4 Russia 581 USD bn
5 India 562 USD bn
6 Taiwan 552 USD bn
7 Saudi Arabia 470 USD bn
8 Hong Kong 423 USD bn
9 Bangladesh 33.7 USD bn
10 Pakistan 4.5 USD bn
11 Sri Lanka 0 USD bn

The total foreign reserves held by commercial banks of Pakistan stood at USD 4.5 billion, taking the country’s total liquid forex reserves to USD 11.42 billion. But with the comparison of other countries like Bangladesh, Hong Kong and India, Pakistan are far away in Foreign reserves. One of the most advantageous positions that a country with considerable foreign exchange reserves enjoys is its currency’s security. These reserves maintain the value of the home currency at a fixed rate. Thus, it safeguards the home currency against devaluation. It also promotes sales. Large amounts of debt accumulated in trade and fiscal deficits can also make repayment burdens unsustainable. Examples include Greece in 2012, Lebanon in 2020 and Sri Lanka in 2022. These were the main reasons for Argentina’s defaults in 2014, Ukraine in 2015, and Ecuador in 2008. An IMF staff mission is scheduled in Islamabad by the end of the month, but the date has yet to be confirmed as the IMF wants Pakistan to make the necessary financial adjustments first. In order to reduce default risk, Pakistan should increase its foreign exchange reserves to reduce the risk of default. To maintain the same exchange rate as demand increases, central banks can issue more local currency and buy foreign currency to increase their foreign exchange reserves. An increase in foreign exchange reserves will help curb inflation and reduce poverty. Sufficient foreign currency is required to avoid default by the debt maturity date. In the end, it is concluding in case of default, Pakistan Socio-economic, political environment would suffer irreparable loss with long last consequences. It is prayed Allah Almighty save Pakistan from such untoward default.

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