BUOYED by the certificate from the IMF on the progress in macroeconomic indicators, upgrading of credit ratings, better internal security conditions, the “resounding success” of the two bond issues in international capital markets in 2014 facilitating our appearance on the radar screens of investors and improved perceptions on the country’s economic outlook, Islamabad ventured for the third time in these markets in less than two years.

It floated a new issue of $500 million expecting that the market’s response, reflecting recognition of these accomplishments, would result in a lower interest rate and oversubscription (as last time), enabling the government to raise $1 billion at cheaper cost.

This fresh foray was ostensibly to augment, or at least maintain, the country’s foreign exchange reserves — already the equivalent of four months’ imports — to meet the IMF-imposed target after repaying the $500m bonds raised in 2006, diversify sources of funding, reduce dependence on multilateral agencies for financing, serve as a good indicator for attracting FDI and for ‘price discovery’.

Islamabad’s overly optimistic estimates have been given a rude shock, forcing it to settle this time around for just $500m and that too at the same interest rate as in 2014, despite all the improvements mentioned above. The rate is significantly higher than that being paid by Sri Lanka, Gabon, Turkey, Egypt, the Philippines and Malaysia.

It is difficult to discern the economic and financial justification for the new $500m bond issue.

Instead of going into the reasons for this tepid market response (although interest rates are low globally), this article will examine the government’s stated motives for tapping into such markets and the erroneous strategy of piling up more commercial debt instead of buttressing its commitment to major reforms.

The argument that venturing into international financial markets will enable benchmark setting (the ‘price discovery’) for the country to borrow in the future is misplaced. Our credit ratings are monitored and revised continuously, being dependent on the government’s management of the economy. The rates at which we can borrow can be different each time we enter the market, being largely ephemeral and transitory in nature and depending on the market’s perception of the economy’s performance. Hence, despite the ‘supposed’ improvements highlighted, we still ended up, one-and-half-years later, paying the same rate as for the last bond issue. With our external and domestic fiscal outlook in the medium term not presenting as pretty a sight as claimed, it’s best that we don’t get ‘discovered’, and remain in hijab!

Other than massaging official egos by demonstrating we can raise debt in international financial markets, it is not clear what has been, or will be, achieved besides the worsening of the debt profile — relatively expensive commercial debt having been acquired although much cheaper and longer maturity debt is available from the World Bank and ADB for undertaking structural reforms. Historically, we have not had a serious external debt issue because it has been predominantly longer tenor in nature and borrowed at less than 2pc, despite the fears of a currency mismatch due to our meagre export earnings.

And this is the more worrying development, considering our external debt indebtedness is already worse than that of our regional comparator countries. Our sovereign commercial debt attracts a rate of 8.25pc, compared with 4.25pc to 6.9pc paid by the countries mentioned earlier (the Indian Reliance group raised $750m at 2.6pc). Interestingly, the government is willing to give foreign savers 8.25pc but Pakistani savers barely 6pc.

Our external liabilities at commercial interest rates will now exceed 35pc of the country’s total external debt, at a time when the principal and interest on the government’s external obligations alone is around 20pc and overall debt 224pc respectively of export earnings, with footloose foreign portfolio investment of $2.8bn that could flow out anytime. Moreover, Euro/Sukuk bonds of $2bn are at variable rates which will ascend when interest rates are raised by the US Federal Reserve.

The servicing of the $5bn stock of bonds at high interest rates and the management of the heavy repayments of external obligations that will commence from 2017 (peaking in 2019) comprising the rescheduled Paris Club debt, the Euro bonds issued 10 years ago and the current IMF programme loan will require more deft handling than what we have exhibited in recent years. These developments will solicit questions on the country’s repayment ability, especially given the depressed growth rate of the economy, debt servicing being a function of the level of country output.

The occurrence of these events will put pressure on the rupee (with its disruptive effects) while exports sag because of domestic policy design and execution issues and an uncertain, volatile global environment, resulting in the disincentivisation of trade liberalisation and continuing distortions in the tax regime and policy environment for business, lowering the efficiency and returns on investment.

It is also difficult to discern the economic and financial justification underlying the new bond issue. The need for liquidity or for settling immediate obligations cannot be driving this decision. Pre­sently, the country has adequate foreign exchange reserves (albeit built entirely on borrowed money), the bulk of them in cash — a non-interest bearing asset.

With the government and the State Bank struggling to productively employ these reserves to earn higher returns on the investments of moneys so mobilised, one is at a loss to understand what the government wants to, or can, do with this additional $500m. Going by present evidence, the government would earn on this amount an extremely modest return from investing in income-earning projects or instruments. The overall result of such transaction would be a large net capital outflow, the servicing cost of the bond being much higher than the income from investments of bond sales proceeds.

The government needs to present its case defending the financial and economic rationale for the decision to float bonds at such high interest rates resulting in the piling up of commercial debt. In this writer’s opinion, the feeble response of the market has given the government a good dose of grim reality. It should now focus on strengthening its resolve to implement long postponed fundamental reforms, remove the remaining impediments to a friendlier environment for investment and reduce the cost of doing business, instead of expending energies in areas that will increase the country’s liabilities for uncertain gains.

The writer is a former governor of the State Bank of Pakistan.

Published in Dawn September 29th, 2015

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