Investors shun Pakistani bonds over rising default threat

Investors are wary of Pakistan’s default on Sri Lanka as the South Asian country grapples with rising commodity prices and tighter credit conditions.

Pakistan’s foreign bonds maturing in 2024, 2025 and 2026 are trading briskly in distressed territory, according to Bloomberg data, at about 71, 65 and 63 cents per dollar, respectively.

The country’s debt was one of the worst-performing of all emerging markets issued this year, pointing to investor concerns about pressures on the developing economy.

The surge in global energy and food prices since Russia’s invasion of Ukraine in February has fueled inflation and widened Pakistan’s trade deficit, depleting its reserves. With foreign exchange reserves shrinking to about $9 billion, enough to last another two months, a liquidity crisis is imminent.

“When we entered the crisis in Ukraine, Pakistan was not in a good position to start with,” said Gareth Leather, senior economist at Capital Economics. “The explosion in commodity prices has led to a rapid deterioration in the current account and rising government spending.”

The discount on the country’s bonds remains smaller than for other emerging markets. This is due to the expectation that an IMF bailout combined with bilateral financing support could help Pakistan avoid default this year.

Ghana, which, like Pakistan, is struggling with rising prices and seeking help from the IMF, has bonds that expire in 2026 and trade at about 68 cents on the dollar. Sri Lanka’s, which defaulted in May, is trading at about 32 cents.

Still, as a sign of the loss of confidence in the Pakistani economy, the rupee has fallen more than 15 percent against the dollar in the past three months, although it came off a recent low of Rs 240 last week to trade on about Rs 224.

The three major credit rating agencies – Fitch, Moody’s and S&P – have all lowered their outlook for Pakistan to negative in recent weeks. The company’s credit ratings are deep in the non-investment grade or “junk” range.

Some market participants have endorsed the view of Pakistani officials that allies, including the US, China and Arab countries, will prop up by providing financial support, as they consider the nuclear-armed state’s economy too regionally important to fail.

The IMF will hold a board meeting in late August to discuss approval of a $1.2 billion disbursement to Pakistan “once sufficient funding guarantees have been confirmed,” said Esther Perez Ruiz, the agency’s representative in Pakistan, last week.

Murtaza Syed, the acting governor of Pakistan’s central bank, told the Financial Times in late July that the country was in talks with countries like China and Saudi Arabia to get additional financing.

Pakistan has a combination of Chinese and IMF support that is likely to converge, unlike, say, Sri Lanka or El Salvador,” said Kevin Daly, emerging markets debt portfolio manager at Abrdn. “They don’t have the same level of support as Pakistan.”

Although Pakistan has received bilateral support in past crises, analysts said political instability could falter in its efforts to regain its financial position.

“We still have a premise that Pakistan will get board approval for a staff-level agreement so that some IMF funding gets through,” said Krisjanis Krustins, a director of the Fitch Asia-Pacific sovereign rating team, adding that this further bilateral and multilateral government funding.

However, he added: “We have a negative view, and that is around the risk coming from politics and what that could mean for the execution of the deal.”

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