The Eurobond narratives

May 12, 2014

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The narratives related to successful floating of five and 10-year Eurobonds may be centred around cost and benefit analysis.

The benefit side of story highlights the restoration of confidence of international investors; increase in much-needed foreign exchange reserves and fulfillment of net liquid foreign exchange requirements under the Extended Fund Facility of the IMF.

The cost side of the story signifies expensive international commercial loans at much higher interest rates than those of other countries; dramatic appreciation of rupee vs. dollar, hurting the low value added exports which ultimately neutralises the impact of this successful launch.

However, a few important points are missing from this narrative which may draw the attention of policymakers, business and economic analysts to further the debate. The policymakers in Islamabad are tapping the international debt market on the assumption that the economy has the dollar earning capacity to service such expensive commercial loans when they become due in future. By borrowing through international debt market, Islamabad is trying to relax the borrowing constraint for fulfilling the political aspirations as quickly as possible.

Normally this kind of decision-making requires astute planning and execution to ward off liquidity problems. The lesson of history is that Pakistan is vulnerable to liquidity problems owing to low value added exports since exports provide the dollar earning capacity. The country is unable to fulfill the commitments made to the lenders and balance of payments crises break out.

The only option under these crises is the recourse to the IMF. Since the current export structure is not sophisticated and the export market is even limited, the public policy debate should focus on increasing the export earning capacity through product sophistication and tap new markets to fulfill the loan commitments in future.

Furthermore, the narratives of foreign and domestic debts are described through the perspective of expensiveness. It is normally propagated that foreign debt is cheaper than domestic debt and domestic debt servicing cost is reduced through foreign debt which provides the basis for tapping the international debt market.

The very question of this debate needs to be reframed as such. Whether the government can default on domestic debt or not? The simple answer is that a government can never default on the domestic debt and the reports of State Bank of Pakistan mention this point. However, a government can default on to its external debt and commitments which has happened to many emerging and developed countries. The peripheral countries of the European Union such as Greece, Ireland, Portugal and Spain defaulted on their external commitments and they are facing belt tightening at the moment.

In a nutshell, the debate of tapping the international debt market should include the above mentioned considerations. The key to this narrative should be the level of sophistication of export structure and the market.

However, the current international capital flow would increase the external debt commitments of Pakistan in future. The policymakers in Islamabad should plan and prepare to negotiate the future external debt commitments now. Otherwise, the balance of payment crisis would break out in the future and the country would be back to square one.

There is also a need to reframe the question of structural change. What kind of structural change Pakistan needs? Since this question has different connotation, I leave this question for the readers to decide.

The writer has completed PhD Economics from the School of Business, University of New South Wales, Canberra, Australia.