Sunday, November 2, 2008

Should Pakistan Default?

The article below was originally published in The News recently, and has since appeared in several places on the web and the blogosphere and seems to have gathered some sort of a cult-following. Here, we examine some of the assertions.

Forget IMF, Pakistan Should Default

(Foreword by WWW.AHMEDQURAISHI.COM: This is serious. If you know President Zardari, please take this article to him. Pakistan does not have to go to IMF and we do not have to service debt. This is an opportunity to spend our money rebuilding our economy and nation. Pakistan is trying to avoid defaulting so that the PPP government can stay in power, and so that while it stays in power, it can continue to borrow money. The real question here is: where is all the money going and why does Pakistan need to keep borrowing it? Let’s tighten our belts and spend the money we have to make a pro-Pakistan trade policy and creatively market Pakistan. Please don’t go to IMF. Please default. South Korea, Thailand, and Indonesia have done it. They have survived. So can we.)

By MOSHARRAF ZAIDI, Tuesday, 28 October 2008.

ISLAMABAD, Pakistan—Pakistan is not going to default, because nobody will let it. That's too bad. Don't let the "economists" scare you. Default sounds like a dark, scary, doomsday scenario. Sovereign default sounds worse, like God's curse itself.

It is not.

"Sovereign" is the fancy term for country, used by the same loan sharks that milk pensioners to fatten their year-end bonuses (and who brought you Wall Street Meltdown 2008). Sovereign default is simply a country not making its loan repayments on time. It has happened to plenty of countries. They are all still around.

Ex-bankers and former IMF employees will never advise Pakistan to default because to do so would be counter-intuitive. It would be like expecting the PPP to undertake land reforms, or the Jamaat-e-Islami to be consistent about anything.

Advising Pakistan to default would represent an existential crisis worse than sovereign default. People would be forced to revisit the premise of their entire careers. We can't have that. So instead, we have experts from all around the world wringing their hands, loosening their ties and extolling the virtues of the "bitter pill" of yet another IMF program. The purpose? To avoid the "dreaded" default, at all costs.

Why is default such a "scary" thing, and why do countries go to extraordinary lengths to avoid default?

Countries try to avoid default for four reasons:

1. First, countries try to avoid default to save the country's reputation as a borrower in good standing—which means that they want to continue to borrow at rates that are favorable to them.

2. Second, countries try to avoid default to save their ability to participate in international trade freely—which means they fear having sanctions imposed on them for being poor managers of their affairs.

3. Third, countries try to avoid default to protect domestic banking and financial system—which means in essence that they want to protect the rich, because there aren't many poor folks with bank accounts.

4. And finally, the fourth reason countries try to avoid default is to save the government of the day from the disgrace of having defaulted.

Eduardo Borensztein and Ugo Panizza published an IMF working paper earlier this month that exposes one of the worst kept secrets in international development. They conclude that among all four of these reasons to avoid default, the most compelling, based on the evidence, is politics. They conclude that "The political consequences of a debt crisis seem to be particularly dire for incumbent governments and finance ministers".

In short, governments choose not to default because it is the politically expedient thing to do. The actual economic costs of defaulting, Borenzstein and Panizza conclude, are simply not that high. Moreover, another paper earlier this year (by yet another IMF economist, Ali Alichi), suggests that the only real reason that countries repay the sovereign debt that they owe is to continue to be able to borrow money.

In short, Pakistan is trying to avoid defaulting so that the PPP government can stay in power, and so that while it stays in power, it can continue to borrow money. The real question here is: where is all the money going and why does Pakistan need to keep borrowing it?

Most of the money is going to debt-servicing and to defense. The traditional response to unsustainable expenditure in Pakistan is to call for a cut in defense spending, while continuing to find a way to pay off Pakistan's loans. No one ever actually explains what they mean by cutting defense spending, which is why the conversation begins with a request to cut the defense budget, wanders into the patriotism of those demanding the cut, and ends with a straight-faced refusal.

No one expects Pakistan to compromise its national security, but it is not unreasonable to explore more efficient ways of securing the nation and the national interest. Far from a national conversation about spending priorities however, no one has gone so far as to even suggest a more traditional and hawkish view, for example, that the war on terror being waged by Pakistan's soldiers needs all the financing it can get, and that Pakistan's debtors will have to wait. An even more refreshing case to make would be to suggest that both debt servicing and national security are major drags on current and future generations, and that they represent much lower priorities than building infrastructure, fixing the police and delivering real education. What would a Pakistani government that was committed to those priorities look like?

For starters it would:

1. Stop hiring poorly qualified political workers to stack the deck for future election campaigns. Forget hiring another ten thousand jiyalas as teachers, to ruin another generation of children. Let's face it, Pakistan cannot grow teachers on trees, it doesn't have any teachers. It has to go out and hire the best Indonesian, Turkish, and Korean teachers. It has to bring them to Pakistan and put them to work. Pay them real salaries.

2. Hire the Emiratis that have designed Sheikh Mohammad's infrastructure revolution to do the same thing to Karachi.

3. Then go out and hire every willing CBM, FAST, GIKI, and IBA graduate out there, and make cops and municipal administrators out of them. Take ten of those supercops, give them Blackberrys, night-vision goggles, Humvees and some ammo and put them outside every school. Forget the entourages. Protect the schools.

4. Take the municipal administrators and tell them to get running water to those schools. If there's no well, and no groundwater, teach them how to negotiate deals, so they can buy truckloads of mineral water for the students, and their mothers. Get those kids and their families some clean water.

5. Make sure there are nurses and doctors at each school. Pay every Aga Khan University Medical School graduate twice what they would make as residents at Mount Sinai or Beth Israel.

6. Teach the kids their native languages, drop the grammatically dreadful and aesthetically murderous fake American accents and bring back the Pakistani accent to film, television, radio and to dinner parties.

That's the kind of expenditure that would explain indebting future generations of Pakistanis. It would explain deepening the pool of debt that Pakistan is drowning in. It would explain the helplessness currently being feigned by economic and political policy makers. In short, if Pakistan was borrowing money to pay for this kind of a social program, it would be hard to argue against it.

Instead, Pakistan is borrowing money to throw it into the same black hole that the money has been going into for at least a generation now. What has Pakistan got to show for almost forty years of sustained debt growth? Illiterate fanatics who can't pronounce the name of God are taking over Swat because the courts don't work. Drug lords and criminals posing as religious vigilantes are taking over NWFP because the cops don't work, can't work, and aren't allowed to work. The water in the taps all over the country is toxic. The teachers at the school can barely read. The ones that can spend more time in Lahore, Peshawar, Quetta and Karachi, at the civil secretariat looking for a transfer, than teaching their students whatever little they know. The students are at home watching Sanju Baba kill bad guys, and Jon Abraham seduce bad girls. The mullahs are making speeches they don't understand, to crowds that aren't listening, until they bring on the hate. Then everybody listens. The uncles and aunties think cheap Broadway rip-offs with racy costumes constitute a culture renaissance. Little girls in rural Pakistan meanwhile are being traded by remorseless jirgas, in the name of honor. The culture vultures hate Arabic, love Punjabi, and are addicted to broken English. The hawks want beef, the doves want bhindi. And bankers want to loan Pakistan more money to finance the whole rot all over again.

It's time for Pakistan to start spending its money on people servicing, instead of debt servicing. Bigger and more successful countries have done this before including Indonesia, Russia, and Argentina. Pakistan loves to ape other countries. Now is its chance. Time to default.

The original version of this article first appeared in The News International. The writer is an independent political economist. Email:

© 2007-2008. All rights reserved. The News International & Verbatim copying and distribution of this entire article is permitted in any medium without royalty provided this notice is preserved.


For analysis, default on Foreign Debt must be subdivided into that on bonds issued by it, or foreign commercial bank debt, or that of bilateral &/or multilateral International Financial Institutions (IFIs), or any combination of the above.

The consequences of a sovereign default on foreign debt of any kind would depend upon the reason for doing it in the first place - the "Inability to repay", or the "Unwillingness to repay".

The author mentions defaults of South Korea, Thailand, and Indonesia. All of these were foreign bank defaults (not bonds or IFIs) from 1998 to early 2000s due to an inability to repay after the far-eastern currency crisis, and lasted for 1-2 years at most.

Pakistan too has defaulted both on foreign bank debt as well as its foreign bonds between 1998-1999 after the nuclear tests - but soon began repayments. The freeze on foreign currency accounts was also a default of sorts, though of yet another type which was unilateral restructuring of on-demand domestic Govt FX liability into a long-term liability. Borensztein and Panizza quoted by the author were referring to this kind of default in their IMF paper - "Inability to repay".

Default due to "Unwillingness to repay" is however quite a different story. To illustrate this type of default, the examples of South Korea, Thailand, and Indonesia are not relevant.

There have been few defaults of this nature, mostly during the South American debt crisis of the 1970s/80s which were eventually resolved through debt-equity conversions and write offs by foreign lenders. Peru was perhaps the most extreme case in South America which defaulted on IFIs alongwith commercial banks and its bonds.

None of these, though, defaulted on foreign trade obligations. Nigeria was the only one which did on that too alongwith all other types - with disastrous results and had to suffer the most severe consequences i.e. complete collapse - despite its considerable oil wealth.

I suspect the author in this article advocates the latter type of default i.e. due to "Unwillingness to repay", of a kind more like Peru while not going to the extent of Nigeria.

This kind of default, in addition to collapse of the domestic financial sector, renders the local currency worthless due to capital flight and hyperinflation, turns the entire economy into a cash economy with no formal credit of any sort, all imports of essentials need to be via hard currency in cash including oil since letters of credit are not accepted abroad, assets abroad including ships and aircraft at foreign ports are seized - basically total anarchy with an economy of carpetbaggers, smugglers, and bootleggers for needed foreign goods.

If the Government tries to counter this with printing currency for subsidies etc for an impoverished population, the hyperinflation is fueled further and turns into a vicious circle almost impossible to break. The Weimar Republic of 1923 is an example with housewives burning currency notes for firewood (above right), and money carted around in wheelbarrows (below).

In societies already fractious such as Pakistan, as was the case in former Yugoslavia, this often results in civil strife, war, disintegration, or rise of a Hitler as in case of Germany's Weimar Republic of 1923.

I'm sure the author would not like this to happen. We need to be very cautious when talking about Sovereign Default.


Observer said...

I have read this article in a national daily and was surprised to know that in this age, our mainstream media can come up with such stuff. I considered it another 'khutba' of an 'economic mullah' who wishes to defeat USA.

Iran is an example, they are the giggest producers of crude oil, but because of 'samctions', unable to refine and are dependent on imports. Although they acquire through many countries. But being a defaulter is far ahead of sanctions.

1. In developing word, there is only one way to achive development and that is, I would quote Dr. Mahatir: "Let the cake grow and everyone have a bite".

2. What does that means, is, development needs money, which we do not have, there would be many who will take undue advantage, lenders will charge intrests, investors will make profits, coprorate will have a party and obvoisly, there will be corruption ...but end result is a developed state....not a bad achievement.

3. In case we dont let investors corporations and lenders make profits they would find some beter returns somewhere else and there is plenty of oppertunities around the world, each state offering better incentives.

Lets us see why we need to borrow:

a). Our total imports are US$ 20 and exports around 10Billion, we get around 5 Billion remittences and around that much through privatisation.

The end result is if we continue privatisation, we are able to pay out import bill, otherwise we have to borrow to meet our imports.

Some 'scholars' like Kamran Khan on GEO Tv would suggest to 'ban' all imports. This is simply not possible as we have signed several FTA's, WTO, reduction on import duties and so on and no state in world can do this unilaterly.

Furthermore, we get favours from countries from where we import in shape of places for Pakistani expats and our substanderd exports. In case we rise the duties or ban any of their items, we would loose same way.

It is simply impossible except we increase our exports. But for exports we need to modernise our industry and that needs technology which costs $$$$. Even if we are able to reduce our imports by some miricle stick, still, we have at the most 15 Billion foreign exchange comming in, which is hardly enough to meet with our import bill.

Now lets us see, why we need loans:

As our import bill is higher and privatisation has come to stall, we need to meet the deficit by loans. Secondly we are living in a stane age and need to develop infrastructure, upgrade our production base and improve quality of life. Our exports do not support that development. There is only one alternate: THE DEBT

Once we default, which means we are unable to repay our lenders, what we have to let the dreams of development go, forget about building energy plans, building dams, acquiring defense equipments, explioting our natural resources and improving our industrial base and agriculture sector, which is severly short of funds.

As a Chiese Prime Minister once said, 'foreign debts take away a large part of national income, but are inevitable for fast growth', we have no choice except to borrow and inject in our infrastructure to become competative producer and exproter.

Default means that no one is going tolend us in future, what development we can do with such a small economy? At this stage we need to borrow as much we can and from where we can. Once our economy is stable, infrastructure is sufficient and our production base is developed, we can start reducing our dependance on debts.

But that stage will come much late, US is the biggest borrower in world with 11 Trillion debt, we have foreign dets of around 50 Billion, just a friction of per capita debt of USA.

Even with such a huge economy which produces almost everything, USA can not think of defult. What to talk about Pakistan which is entirely dependent on imports right from agriculture to defense and oil to industrial equipments.

If we can secure more loans, we can inject more in to inftastructure and industry. Meaning thereby that we multiply our GDP. Which will generate jobs, improveliving standerds, increase exports and circulation of money. Default is economic isolation in 21 century when economies are intervowen to the xtent that no state can survive in isolation.

Bottomline is 'let the cake grow and everyone have a bite'.

Anonymous said...

I feel a particular group is wishful that USA could be taken to task if confronted politically. The premise for this confrontation lies in political anarchy. Militancy is the obvious power that would fill the vacuum.

Its something akin to, 'I am committing suicide. Come and save me'.
Samson Simon Sharaf

Zeemax said...


No amount of Debt is bad as long as one has the ability to service it through a more than proportionate increase in production of goods and services. It's no good if it's only used to meet deficits. So, broadly speaking, I agree with you.

Foreign Debt, FDI, Portfolio investment, all are a transfer from countries with excess Capital to those with a shortfall in the same, and flow naturally from one to the other.

Prudent economic management by the recipient country is the key, which unfortunately has not been the case in Pakistan.

Zeemax said...

Samson Simon Sharaf,

I too am at a loss to understand the weird alliances being formed, and for what purpose?

The writer of the foreword, Mr. Ahmed Qureshi, was the media man entrusted by PTV to promote and defend the Globalization economic policies of the past regime, and now he wants Pakistan to default? Unbelievable.

Observer said...


I am not an idealist, and I am still trying to find out an organisation or a country which has ideal working conditions and planning or even transparancy.

Corruption is as much inevitable as development.

As regards your statement about mismanagement, I wont agree with that although to a certain extent you are right, but again where it do not exist?

The problem is a size, if we have a trillion $ economy and Nawaz, Zardari or Shaukat Aziz escapes with a couple of billions, it wont hurt as bad.

To my understanding the fault remains in frequesnt military interventions and unfruitful military adventures which converted Pakistan in to a security state rather then a welfare state.

Our institutions deteriorated and planning become irrelevent, visionary leadership was replaced and development discouraged.

Still, to be honest, we have made significant progress in these conditions and that is atributed to our prople not to our government.

Presently we need to modernise our agriculture, develop non existant industrial base and add value in our exports, this all needs technology and offcourse we do not have it, imports will mean foreign exchange which at this stage we can only have with foreign debts and privatisation.

I am not disappointed about future, our people are demanding and we might have some visionary leadership soon then later. The only thing which makes me worried is writer of this article Musharraf Zaidi and people like Brasstacks Zaid Hamid and Ahmad Qureshi who have links with agencies and come up with such ideas which are appealing to a man in street but recipe for suicide. I wish I am wrong and once again our agenies are not in process of imposing something like an Iranian model on us.

Observer said...


Sir, It is not 'excess capital' which plays role in transfer of funds from one state to other. It is investor's greed. As you know better markets are run with fear and greed. Today Pakistan is victim of 'fear'.

If today investor have oppertunity to make huge profits, he will pul out his money from his own country, even if it goes bankrupt to make these profits. May be not all but majority of them.

Industrial and agricultural infrastructure in non existant in Middle East, while ME investor is busy investing in foreign lands. Complete transparancy and prudent economic management (in terms of controlled profits not the planning) are also discouraging factors for investors, who obviously wants to have a 'party', and countries like us are left with no choice.

But again thin is if I can double the production at my farm by borrowing from Bank, why should i hasitate to pay bank 20% for 200% increase in my out put.

BTW....If i was decision maker in Pakistan, I would go for at least a trillion $ loans for our agriculture, industrial and natural resources sectors (if possible to borrow).

Zeemax said...


George Soros had said: "Free-flow of capital between nations means the destruction of societies". It is true.

That is what I meant by mismanagement, i.e. lack of sound Government policy & regulation, not corruption which is commonplace and hardly decisive - unless it achieves Nigerian proportions.

Do read the blog entry of Tuesday, October 14, 2008

Observer said...


Thanks, interesting read......

I believe it was some thing very personal between Mahatir and Soros to settle.

I love the guy as much Mahatir hates him, money has to be with 'claver' not with idiots, rather then claver managing it for idiots....lolz