😱 Pakistan Close to Bankruptcy?
Pakistan is once again very close to economic collapse and this could be bad for India. Here's why.
Another one bites the dust.
Yes, yet another neighbour of India is close to an economic crisis and a probable loan default: Pakistan (here's what happened to our other neighbour, Sri Lanka).
Reports suggest that Pakistan's 5-year credit default swap rate reached an all-time high of 92.53% last weekend.
But what is a credit default swap rate? And why is Pakistan in trouble?
🤔 What is A Credit Default Swap?
Let's say you bought a 10-year Chinese government bond in 2018 for investment purposes.
Turns out in 2 years China saw a massive Covid wave shutting down the economy.
Now, you no longer believe that the government has the ability to pay you back. But you also feel there are chances China could bounce back. However, you don't want to take a huge risk. So, you get insurance for your bond. How?
Through a credit default swap. You buy this credit default swap from another investor who promises to pay you back if China defaults.
Wait, what's in it for them? Why would they promise this? Because in return you have to pay them premiums till the bond matures or till China defaults.
So, these credit default swaps work like an insurance policy and the investors issuing them are like insurers.
Now, the rate of these credit default swaps depends on market conditions. If a large number of investors feel that a country is going to default on their loan repayments, a lot of them start buying these credit default swaps, increasing the rate.
So, now the question is why is Pakistan's credit default swap rate so high? Why do investors feel it won't be able to repay bond payments?
🧐 What's Happening in Pakistan
The country is in a lot of trouble, both politically and economically (you can read about its economic troubles here).
First, let's talk about the political situation.
The country is seeing a lot of political upheaval since its ex-PM Imran Khan was removed from power in April.
A no-confidence vote was passed against him, with the parliament blaming him for economic mismanagement and poor handling of foreign policy.
Since then, a new PM, Shehbaz Sharif, has come to power but the country has been divided, with many protesting the change.
Now, this political turmoil on its own would not really impact Pakistan's economy. But this mess comes when Pakistan is already economically weak. Wait, how?
Well, where do we even start from?
First, there was the economic crisis from China's Belt and Road Initiative. The initiative aimed to create a lot of infrastructure in Pakistan. But like most countries, it saw delays, mismanagement and corruption.
Ultimate result: No development, high debt.
Just when Pakistan was trying to recover from this crisis, nature ruined its plans. Massive floods killed thousands of people and animals and destroyed crops worth millions.
So, not only was Pakistan left much poorer (due to loss of life and property), it also had to spend what little it had in its coffers to help the common public.
Now, amid all this despair and destruction, there was a small ray of hope for Pakistan. The IMF, the global rescuer of countries, gave it a $1.17 billion loan (total loan received from IMF $4.2 billion).
China, the World Bank and the Asian Development Bank have also given the country some loans but since Pakistan is hardly making money, its foreign reserves and the price of its currency are both falling.
In fact, Pakistan currently has only $7.959 billion worth of foreign reserves (as on November 11), which are enough for less than six weeks' imports.
Some reports suggest that Pakistan's coffers have long been empty and the amount of forex reserves left are all there, thanks to loans.
Okay ReadOn, we get having loans and liabilities, but why has Pakistan's income dropped so much?
Well, the country has two major sources of income: Exports and Remittances. And they are both falling. Why?
Exports are down because the country's crops have been destroyed. What's more, it has started importing more and more stuff from Afghanistan (lowering its forex reserves).
The import drive from Afghanistan started as a move to help the country which had just been taken over by the Taliban and was cut off from the world.
Meanwhile, exports are down.
And what about remittances?
Thanks to Covid, fewer Pakistanis have been settling outside the country. So, less money is coming in as remittance. Plus, abroad-settled Pakistanis are also sending less money home due to bad economic conditions.
So, Pakistan is facing trouble from everywhere. Which is why people are worried it may not be able to pay off the $1 billion bond payment that is due in December.
But there's still a silver lining to its cloud. The appointment of a new army chief in the country has given a lot of hope to investors, bringing down the credit default swap rate to 71.64%.
Plus, according to Bloomberg's calculation, Pakistan only has a 10% risk of defaulting.
The country has also raised the interest rate to 16% to deal with other problems like growing inflation.
Now, we'll have to wait and watch whether or not Pakistan makes it.
But the economic crisis could force the country to build stronger ties with China, a move that would harm both the US and India.
So, what will Pakistan do? Only time will tell.
⚡In a line: Pakistan could possibly be defaulting on its loan due to political and economic turmoil.
💡Quick question: Do you think ending its rivalry with India could help Pakistan?
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