Central bank's foreign exchange reserves and external public debt, US$ millions

Pakistan’s foreign exchange reserves have plummeted to unsustainable levels

If Pakistan defaults on its debt, it will have wide-ranging implications on firms’ operations.

In the immediate aftermath of a default, the government is likely to impose strict capital controls on funds in commercial banks, preventing companies and individuals from taking their money out of the country. Consumers are likely to hoard essentials, causing large-scale shortages, extreme inflation, and likely riots in the streets. Shortages of manufacturing inputs and breakdowns in supply chains will also severely impact business operations.

Over the medium term, firms should be prepared for massive changes in policies associated with taxes, subsidies, and investment. These changes could arise either as part of conditions of debt restructuring programs, a change in government in the upcoming election, or likely both.

Overview

Pakistan’s most pressing concern is its rapidly depleting foreign exchange reserves, which are currently sufficient to cover just three weeks of imports and less than one-tenth the current value of its external public debt. In response, the government has implemented emergency-like measures, such as restricting imports of select discretionary products, limiting operating hours at commercial establishments, and capping the outflow of foreign exchange by outbound travelers. The government has also launched a series of diplomatic efforts with friendly nations to request emergency funding. Recent news reports indicate that the government has secured emergency funding from Saudi Arabia and a partial rollover of its loans due in the coming months.

Our View

While the emergency funding from friendly nations has allowed Pakistan to avert a debt default so far, these cash infusions are only stop-gap measures and do not preclude the likelihood of an eventual debt default. Firms in Pakistan should continue to plan for the likelihood of a debt default in 2023. In this situation, a combination of some or all of the below outcomes is likely:

  • Debt restructuring: The IMF and other international creditors outline a process to restructure Pakistan’s debt, but at the cost of significant austerity measures and major changes in economic and fiscal policy.
  • Currency devaluation: After several months of using foreign exchange reserves to artificially maintain the value of the Pakistan rupee, the government and central bank will likely be forced to devalue the Pakistan rupee.
  • Political upheaval and social unrest: Currency shortages and tight austerity measures that follow will likely cause widespread social unrest. With general elections likely to be called in the coming months, the ongoing economic crisis is likely to trigger a change in the government.

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