Pakistan Faces Default on Its Huge Foreign Debt

Starting a few months ago, the $24 million import bill for Pakistan's Conductor & Cables, a Lahore-based steel business that employs 300 workers, became a drain on the country's most precious resource—the U.S. dollar. As the global credit crisis has intensified and Pakistan has steadily seen its foreign reserves dwindle, privately held Conductor & Cables is facing its toughest challenge yet. In an attempt to preserve its foreign exchange, the Pakistani government has told importers they must provide for one-third of their import bill in cash before a bank can issue letters of credit. As a result, Chief Executive Muhammad Imran Khan's imports are down by 50%. "My company is in a pretty deep crisis right now," he says. "But so is the country."

This is what it feels like when a country faces bankruptcy. The electricity goes out for as much as 12 hours a day, the gasoline lines get longer, and depositors rush to banks to pull out their meager savings. After weeks of begging in vain for help from the international community, Pakistan's foreign exchange reserves have dropped to just $4.3 billion, down nearly 75% in the past year because of soaring prices for commodities, particularly oil, which accounts for about one-third of imports. The country presently has only enough cash to pay for about 45 days of imports at current rates. And the rupee has lost about 25% so far this year. Unlike Iceland, whose economy collapsed (BusinessWeek.com, 10/9/08) as a direct result of the global credit crunch, Pakistan's problems are largely homegrown. Indeed, its banks are well capitalized and did not get caught up buying fancy debt securities linked to the U.S. housing market.

Raging Inflation

Already the country has cut its oil imports so it holds no more than 10 days' supply at any given time. Inflation is raging at more than 24%, and for the first time in a decade, Pakistan's economic growth this year will drop below 5%, according to economists' estimates, compared with 6.5% last year. For the $146 billion economy in Pakistan, a mainstay in the Bush Administration's war on terror, the crisis could not have come at a worse time. Since 2001 the U.S., Pakistan's traditional ally, has given the country as much as $10 billion in military aid.

With the global economic system already in shock, were Pakistan to default on its massive foreign debt obligations—which it has done before—the impact would be painful. At the same time, the West needs Pakistan's newly elected civilian government to remain stable: Pakistan's nuclear arsenal was never completely secure in the best of times, and now, with an increased offensive by the Taliban in Peshawar, the biggest Pakistani city near the border with Afghanistan, Pakistan's role in the global war on terror has never been more important.

With global arteries of credit still constricted, Pakistan's already toxic debt—rated the second-worst in the world by Standard & Poor's—makes it impossible for the country to get bridge loans to make partial payments on outstanding loans. Just this past week, Pakistani President Asif Ali Zardari used his first state visit to China to ask for a loan to Pakistan's central bank, reported by Chinese media to be as large as $2 billion. China said no, but offered to increase bilateral trade and will consider building two nuclear reactors in the country.

Huge Debt Burden

Pakistan's debt burden is significant. It has nearly $3 billion in commercial foreign debt and $38 billion in concessionary loans from the International Monetary Fund and the Paris Club, an informal lending group of about 20 countries, according to an estimate by Credit Suisse (CS) analyst Farid Khan. Payments on dollar-denominated bonds continue, but in February a $500 million bond comes due, bringing debt servicing costs for 2008 to more than $3 billion, according to a government estimate.

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