Pakistan near debt default

Barely a month since the presidential election, falling foreign currency reserves have forced PakistanÆs new government to turn to the IMF for a loan.
PakistanÆs foreign reserves have fallen sharply in recent months. At half the level they were a year ago, the country now stands on the precipice of defaulting on its international debt.

In order to avoid a default, PakistanÆs government has turned to the International Monetary Fund (IMF) for a loan. News reports estimate that Pakistan is seeking between $4 billion and $15 billion in loans from the lender of last resort. Neither Pakistan nor the IMF has confirmed an amount.

According to PakistanÆs central bank, as of October 10, the country had only $7.75 billion in total hard currency reserves. This is down from a six-year high of $15.6 billion last year.

Royal Bank of Scotland's chief economist for Pakistan, Sakib Sherani, says that in net terms the country only has around $4 billion in foreign exchange reserves, enough to cover debt obligations for two months. At current expenditure levels, Pakistan has a net outflow of $1 billion per month.

For the first half of 2008, Pakistan had a current account deficit of $14 billion û 3.5% higher than predictions and double the total for fiscal year 2007. The deficit is equal to 8.4% of GDP.

Standard and PoorÆs downgraded PakistanÆs long-term sovereign credit rating to CCC+ on October 6, while MoodyÆs Investor Services has maintained its B2 rating.

Activity on the Karachi Stock Exchange, PakistanÆs largest, has been negligible since the exchangeÆs board of directors set a price floor for the benchmark index at 9,144 points on August 28. The freeze was a reaction to a 41.7% drop in market capitalisation since the market hit a high of 15,676 points in April. The index closed at 9,186 points yesterday.

IMF loans are stigmatised by memories of the debilitating structural adjustment facilities in the 1990s. Spending cuts and tax hikes would most likely be a condition of a new loan by the IMF to Pakistan and such conditions could prove politically debilitating to the recently elected democratic government of President Asif Ali Zardari.

"At this point there is no other option for Pakistan than what the IMF is bringing to the table," says RBS's Sherani. "Pakistan has completed most of the typical pre-conditions for an IMF programme. However, on the fiscal side, Pakistan will probably have to reduce its budget and further tighten monetary policy."

Pakistan has found little support among the loose five-country Friends of Democratic Pakistan group, which includes China, Saudi Arabia, the United Arab Emirates, the US and the UK. The country initially approached China for a loan, but during President ZardariÆs visit to China last week he was unable to get a guarantee for a needed $4 billion to $5 billion loan. China has foreign exchange reserves in excess of $1.9 trillion.

Loans from China or other members of the Friends of Democratic Pakistan are preferred to those from the IMF because they do not come with as many strings attached.

The western members of the group have also pledged little support. Last week, the UK said it will increase aid to Pakistan to $825 million over the next three years. And on Monday, US assistant secretary of state for South and Central Asian Affairs, Richard Boucher, met with Zardari and specified that the US will only loan Pakistan limited ôcarefully targeted aidö.

The recently elected Zardari government faces a troubled domestic situation. Since the beginning of the year, Pakistan has been adversely affected by inflation, food shortages and an ongoing anti-government insurgency.

Beginning with the assassination of former president Benazir Bhutto on December 27, 2007, Pakistan has completed a transition back to a democratic government amidst declining economic indicators. Since the September 6 election of President Zardari, the credit crunch and terrorist insurgency has intensified the pressure on PakistanÆs economy. At the end of September, an explosion at the Marriott Hotel rocked PakistanÆs capital Islamabad, claiming 53 lives, and the countryÆs northwestern tribal belt remains a hotbed of insurgent activity.

In early October, central bank governor Shaukat Tarin outlined a plan for direct cash transfers to the countryÆs poorest households at meetings with the IMF and World Bank. Such large-scale poverty reduction campaigns would likely be halted under an IMF loan scheme.
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