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Pakistan grapples with prospects of impending sovereign default

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Saad Hafiz
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Begging for "mini" bailouts from "friendly" countries can only postpone the inevitable. Pakistan has to make tough choices as sovereign default appears imminent. Political leaders presently engaged in brinksmanship and partisan politics must prepare the people for the stiff challenges ahead.

Successive governments, afraid of the political costs of default, have dithered on implementing painful austerity measures. It has only brought the prospect of default closer and increased the considerable costs for the citizens. For example, Pakistan struck a crucial IMF deal in June 2022 when high energy import prices pushed the country to the brink of a balance-of-payments crisis. If the government had cut spending then, the country wouldn't be making more interest payments now.

We cannot ignore the dire default outlook. Despite the objections of Finance Minister Dar, Pakistan was among the top five countries with the highest default risk in 2022. The cost of insuring Pakistan's debt against default has surged, and Pakistan's credit spreads have widened. Key debt-rating agencies have downgraded Pakistan's Long-Term Foreign-Currency Issuer Default Rating to "junk" status because of the deterioration in external liquidity and funding conditions and the decline of foreign exchange (FX) reserves.

As a wake-up call for policymakers, default means reputational damage, an exclusion from capital markets, and higher future borrowing costs. It will lead to falling growth rates, a collapsing currency, high unemployment levels, large spikes in poverty, and sharp declines in standards of living -- adverse conditions that could lead to more political and social turmoil.

While not giving up efforts to shore up foreign currency reserves and revive the IMF program, Pakistan must prepare for sovereign default. It must establish an honest dialogue with creditors to agree on a debt-restructuring plan that ensures long-term sustainability and restructure debt-servicing repayments of interest and principal to make these payments more manageable.

The support of the international community and financial institutions, particularly the IMF, is essential in debt-restructuring negotiations. Pakistan has to overcome the trust gap with international financial institutions and investors because of the lack of progress on promised reforms. But a single debt restructuring will not resolve severe economic issues. There is a high risk of Pakistan becoming a "serial" defaulter without fundamental reforms.

It is a monumental challenge for Pakistan to reform an economy based on low productivity, coupled with protectionism in the form of bans and high import tariffs, unsustainable levels of elite consumption, unsustainable debt, and excessive defense spending. Ideally, it needs an economy where government involvement is limited, macroeconomic stability is the norm, saving and investment rates are high, and government budgets are in surplus.

The transformation will require the enactment of market-friendly economic policies in a short time frame that can lead to better living standards, enable wealth creation, and the efficient allocation of resources. Admittedly, a low probability in a crisis-ridden country where a small elite has captured the state and lives off its economic rents. Meanwhile, the poor and the middle class, who have never had a say in the imposed system, shoulder the main burden of every crisis.

Nevertheless, the country's sovereignty and economic survival are at stake. Policymakers must develop a credible plan for economic and financial recovery. With no money in the kitty, politicians should stop selling foolish notions of an Islamic welfare state and the idea that large social programs can pull people out of poverty.

A country needs a culture of hard work, a growing economy, rising exports, and a massive investment in human development to create conditions for people to pull themselves out of poverty. It is especially true for Pakistan, where population growth does not match available resources, thus increasing the likelihood of recurring financial crises.

We know that changing chronic economic mismanagement, reliance on short-term fixes, absence of long-term planning, and begging for bailouts will not be easy. Debt restructuring is not a panacea to cure economic ills.

It can only provide some breathing space.

Shunning wasteful policies and strengthening the fiscal position to create sufficient room to deal with future economic shocks is critical. And providing an enabling environment for everyone to succeed and share the gains of the future can still pull the nation away from the abyss.

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Saad Hafiz is an analyst and commentator.

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