Pakistan will probably avoid debt default

HONG KONG (September 05 2008): Pakistan will probably avoid the sovereign debt default that markets increasingly expect, even though the country faces more downgrades to its credit rating as it grapples with dwindling reserves and a sliding currency. The stability of Pakistan, a key US ally in the war on terrorism, is so important a geopolitical factor that institutions such as the International Monetary Fund will eventually help it meet obligations to creditors, analysts said.

“Is this going to get into a default scenario? No,” said Dilip Shahani, Asia-Pacific research head at HSBC. “Negotiations with the likes of IMF will help stabilise the situation,” he said. Investors are not so sure. Pakistan’s credit default swaps – contracts investors use to insure debt – have been widening since the departure last month of President Pervez Musharraf.

The five-year credit default swaps have jumped 200 basis points to 900/1,000 basis points since Musharraf quit on August 18. That means it now costs at least $900,000 to insure $10 million worth of debt against default, compared with around $700,000 at the end of the Musharraf era.

It is now cheaper to insure five-year bonds of Argentina, which has been in default since a 2001-2002 economic crisis. Argentina’s 5-year credit default swaps are at 780/800 basis points. Pakistan’s credit default swap numbers implied a “a significant risk of sovereign default” in the runup to the maturity of Pakistan’s $500 million bond in February, Citigroup economist Mushtaq Khan said. He too did not think a default would occur. Investors do have reason to be concerned.

DECLINING RESERVES: Musharraf, who came to power in a 1999 military coup, resigned to avoid impeachment, ending months of speculation and sometimes violent protests against his rule. But that kicked off a new phase of uncertainty, especially after the second-largest party in the ruling coalition withdrew support from the five-month-old civilian government.

The political chaos has raised questions about whether government will able to tackle the country’s many economic problems. “It seems the government is not getting its act together, making it difficult to actively address the decline in the forex reserves,” said Yang-Myung Hong, sovereign rating analyst at Lehman Brothers.

Currency reserves have shrunk to $9.38 billion from a record high of $16.5 billion ten months ago, the current account deficit is at 8.4 percent of gross domestic product and the rupee is at a record low, having lost over 20 percent against the dollar this year.

Analysts estimate its foreign exchange reserves can only pay for less than three months of imports, having sunk by around $800 million a month. Import costs have surged in the past year as the price of oil and most commodities hit record highs, driving up inflation to nearly 25 percent. Economic growth is forecast to be the slowest in six years.

NO DEFAULT: A stock market which rallied for six years has slumped 41 percent off a life high in April, and 34 percent this year, making it the worst-performing market in Asia after China and Vietnam.

A debt default will probably not be added to this list of woes. Pakistan’s stability is a vital factor in the war against the resurgent Taliban in Afghanistan, where the death toll is rising among foreign forces. The party of slain former Prime Minister Benazir Bhutto enjoys the support of the United States and other Western nations.

Still the scramble for funds, is keeping markets on edge. Last month, an International Monetary Fund official said Pakistan does not need to turn to the IMF for money in the next 10 months if the government cuts spending and gets other sources of funding to offset falling reserves.

Islamabad is in talks with Saudi Arabia to defer an estimated $5.9 billion worth of oil payments, and is also in discussions with the World Bank and Asian Development Bank for more than $1 billion in loans. Central Bank Governor Shamshad Akhtar said the World Bank was seeking to speed up close to $1 billion in investments as he sought to calm jittery markets.

“If the facilities like the Saudi oil payment deferral don’t come through, then Pakistan could start to face pressure in meeting its external obligations,” said Lehman’s Hong. The bond maturing in February 2009, a thinly traded security, was quoted at 93.50/97.50 cents to a dollar on Thursday. The more active benchmark – the 2017 bond – has dropped by 5 points to 63 cents to a dollar in the past week.

Even if it does not default on the 2009 bond, Pakistan’s sovereign credit rating could be lowered a notch if Islamabad does not improve on its macroeconomic performance. That would make future borrowing more costly. In June, Standard & Poor’s cut the country’s rating to B from B-plus with a negative outlook, meaning another downgrade is on the cards.

Moody’s Investors Service, which downgraded Pakistan to B2 from B1 in May this year, may also cut again if funding is delayed so much that “even some limited amount of assistance may not help Pakistan meet its external obligations,” said Moody’s analyst Aninda Mitra.

Source: Business Recorder, 5/9/2008

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