A message relayed on the WhatsApp broadcast of a brokerage house has kicked up a fuss that’s refusing to subside well beyond the 24-hour news cycle.

The country’s five-year credit default swap (CDS) — a type of insurance against the risk of sovereign default — increased by almost 20 percentage points on a day-on-day basis to a multi-year high of 75.5 per cent on Nov 15.

It took hardly any time to turn the 11-word message into a well-padded story. Then came the onslaught of YouTube videos on the impending sovereign default, and before you could say “verified information”, former PM Imran Khan began using this chatter to set off alarm bells in public rallies about a certain sovereign default. In response, Finance Minister Ishaq Dar broke his silence on Saturday and called such concerns baseless.

But what is the CDS and is it an indicator of default risk?

A CDS works like an insurance policy to protect investors (read: bondholders) from any loss arising out of a country’s inability to pay back its dollar-denominated loan.

Say an investor buys a bond and also goes to an investment bank to buy its CDS. They sign a formal swap agreement under which the bank promises — against a fee or premium — to compensate the bondholder should the bond-issuing sovereign default.

The important bit to understand here is that these figures are bought and sold in the over-the-counter (OTC) market, which has no proper exchange. Hence, there’s no singular CDS rate. It’s compiled and issued by different organisations, just like Pakistani brokers compile the closing exchange rate for the open market every day.

One would assume that the premium — or the CDS level — should range anywhere between a few basis points and a few percentage points. But that’s not the case with Pakistan’s international debt, given its myriad problems. Hence, the mindboggling 75.5pc CDS figure.

In other words, it means a bondholder should, on average, $pay 75.50 to an investment bank to secure or insure every $100 that it’s lending to the government of Pakistan.

But how real is this number and in which universe does it make sense to protect a $100 investment by paying a $75 fee?

“The CDS level shows the cost of insuring against default. It doesn’t tell the probability of default,” Alpha Capital Securities CEO Muhammad Azfer Naseem told Dawn on Saturday.

“The current rate is reflective of the fact that no one is willing to guarantee Pakistan’s debt. Pakistan would find no investor if it wanted to issue a $1bn bond at 8pc today,” he said.

Simply stated, it’s like an overpriced listing on an online property portal: an exorbitantly high rate doesn’t automatically make it the basis for an actual transaction.

This brings us to the question of whether international investors are indeed jittery about the upcoming maturity of the five-year sukuk of $1 billion? The short answer is “no” — even though some highbrow publications have falsely linked the 75.5pc CDS rate to the bond that’ll fall due on Dec 5.

The fact is that few investors expect Pakistan to default in December. For evidence, one needn’t look beyond the current price of that bond, which is hovering just below its near-par value.

Even though the risk of default is minimal in December, the worsening economic situation is sending all kinds of wrong signals to the global capital markets.

“The default risk is definitely high right now. The whole world is heading towards an economic slowdown. There’s a high likelihood of recession. Exports will go down if the recession becomes real,” he said.

Remittances, which are the most important source of dollars after exports, are in decline. Reserves have been going down despite the recent Chinese debt rollover and fresh inflows from the World Bank and ADB. The exchange rate in the interbank market is firmly maintained around 220 while the open-market rate is going through the roof, which suggests an expanding grey market. “The government must ensure the IMF programme stays on track. Default will become imminent otherwise,” said Mr Naseem.

Published in Dawn, November 20th, 2022

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