‘Domestic debt restructuring will be painful’

As the government maintains silence about its next move after declaring its debt “unsustainable,” former central bank governor Shahid Kardar stated on Monday that Pakistan would need to be in the International Monetary Fund (IMF) to qualify for debt restructuring, and the process would be very painful.

Banks may need to take a hit on their principal loans, the central bank may need to relax prudent regulations to lower capital requirements, and high taxes might have to be imposed on cash withdrawals to prevent a run on the banks, according to Kardar.

He delivered a presentation on the prospects of debt relief during the third Pakistan Prosperity Forum organised by the Policy Research Institute of Market Economy (PRIME).

“Pakistan would have to be in the IMF programme to qualify for the debt restructuring,” said Kardar in response to a question.

The Ministry of Finance’s spokesperson did not respond to questions even after three days regarding whether the government has approached commercial banks for debt restructuring.

The servicing of external and domestic debts appears increasingly unsustainable, with Pakistan’s gross public debt now equal to 667% of revenues compared to the average of 214% for more than 20 comparators, according to Kardar. Kardar also pointed out that wasteful expenditures on low-priority and poorly designed projects have made the debt unsustainable. Prospects for recovery depend on progress in restoring debts to manageable levels.

“Debt restructuring is complex, there are no short-cut solutions, and the government would also face issues like foreign currency swap arrangements, deposits with the SBP, bonds with a large number of holders and covered by New York Laws,” said Kardar.

The former governor said that Pakistan may also not qualify for the G-20 Common Framework for Debt Treatment, meant only for heavily indebted countries. Kardar stated that being lower-middle-income, Pakistan may also not get relief under the G-20 framework. He mentioned that bilateral creditors seem reluctant to suspend debt servicing payments due to difficult financial conditions, fearing credit rating downgrades leading to a loss of access to capital markets.

Domestic debt restructuring

Although the Ministry of Finance has not responded to a question on the future course of action, Kardar highlighted the prospects and challenges of domestic debt restructuring.

The former governor said that if Pakistan seeks the write-down of external debt, foreign lenders would also ask in return for similar adjustments in domestic debt. He predicted that banks, being the largest lenders to a bankrupt borrower, will have to bear the burden of some pain.

Read: FM warns of unsustainable debt

Pakistan’s total public debt has already increased to Rs75 trillion or equal to three-fourths of its economy, with interest payments consuming the entire net federal income.

Kardar said that the “reduction or liquidation of domestic debt will require a gradual approach, involving a combination of significantly negative real interest rates, a moratorium and suspension of interest payments for some years, longer maturities, and some write-down of its face value.”

He said that a substantial reduction in the face value of the banks’ lending to the government would hit the capital base of banks, requiring loans to them at concessional rates. A short-term relaxation of the SBP’s prudential regulations on capital adequacy might be needed for domestic debt restructuring. The former governor suggested that, to prevent large cash withdrawals and a run on banks by depositors, the government might have to impose a hefty withholding tax. This would need to be supplemented by the government guaranteeing all deposits for a two to three-year period.

He said that one option could be a higher tax rate on bank incomes, but he stated that it was not a preferred option. Kardar also mentioned that there was not much space for external debt restructuring, as 48% of the debt is owed to multilaterals and is mostly at highly concessional rates. He added that China, which holds 31% of bilateral debt, was already rolling over repayments of $8 billion but was reluctant to accept losses on its lending portfolio.

The former central bank governor found many similarities between Pakistan and Sri Lanka, another country facing a severe debt crisis.

He said that, like Pakistan, Sri Lanka also granted generous tax exemptions and booked a primary budget surplus in only three years since 1951. Sri Lanka, like Pakistan, financed its unsustainable fiscal deficits through foreign and domestic borrowings, resulting in its public debt jumping to 128% of GDP and interest payments being 72% of revenues.

For this fiscal year, the IMF has estimated Pakistan’s interest payments cost at 92% of the FBR’s revenues.

Published in The Express Tribune, November 28^th, 2023.

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