Under What Conditions Will Pakistan Not Default

shehbaz sharif.webp

Pakistan Prime Minister Shehbaz Sharif

San Francisco / July 25, 2022

Pakistan is nearing default on foreign debt obligations. In the past 7 days, the Pakistan rupee fell 7% versus the US dollar:

Source: www.xe.com

The country has less than 2 months worth of foreign exchange reserves (link). Also keep in mind that on July 15, Pakistan Finance Minister Miftah Ismail reached an agreement for the IMF to provide $4 billion in financial assistance (link). Even with that deal in place, the rupee keeps declining. Pakistan is evolving into a classic emerging markets crisis.

There are a few strategies for Pakistan to escape from this position.

First, Pakistan should convince the IMF, China, or Saudi Arabia to provide more and repeated financial assistance. The core goal is to send signals that under no conditions will Pakistan default on its external obligations. If Pakistan can send credible signals, then investors will be less likely to short the rupee. Also, I'm hearing in conversations that many wealthy Pakistanis are taking hard currency out of the country. The Pakistan government should strive to send credible signals that will make the wealthy less likely to move hard currency abroad.

It is difficult for the Pakistan government to convince external players to provide additional financial assistance, but Pakistan should try. The IMF, China, and Saudi Arabia will want something practical in return for the money and unfortunately the Pakistan government must structure a compelling deal. This is how life works for countries that cannot manage their finances.

Second, Pakistan should restructure its internal finances so the nation tracks to financial independence.  The simplest path is to cut spending. There is a lot of corruption by the Nawaz and Shehbaz Sharif Family and Zardari and Bhutto Family. Senior Pakistani politicians must end this practice where they leverage political power to financially enrich themselves. This messes up the balance sheet of the nation. Most people in the United States cannot comprehend the massive scale of corruption by the Sharif and Zardari / Bhutto Families.

I will also float an idealistic proposal -- Pakistan should be friends with India and gradually cut the spending of the Pakistan military. I'm personally familiar with the painful history of war between Pakistan and India. My family was scarred in Partition in 1947 and fought in repeated wars between Pakistan and India. When will the two countries stop fighting, make the best of a complicated history, and strive towards common goals? India is pioneering trends of economic growth in the developing world. Pakistan should partner in this growth and ride the positive wave. India's growth will also accelerate if there is an end to hostilities. When I float this idea in conversations with Pakistani relatives, people find this ridiculous. But I sincerely believe it is the long-term path forward.

If Pakistan makes peace with India, then Pakistan can spend less on the military and that will help the country develop financial independence.

Third, Pakistan can implement micro-structural changes. The Harvard economist Asim Khwaja proposed a very good list a few days ago on Twitter (link). Asim Khwaja's core point is that Pakistan will keep drifting into near default unless there are structural changes to the economy. For example, he suggests that Pakistan raise productivity rates across all industries. This will take a significant mindset change because in Pakistani culture, people aspire to be "above work". In contrast in Silicon Valley, the entrepreneur takes pride in his work.

It is not a done deal that Pakistan evolves into Sri Lanka, where mobs overran the capitol buildings. But that can happen. The Shehbaz Sharif Government must act now to change the trends.

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