Anjum Naveed/AP
Pakistan's Prime Minister Yusuf Raza

Pakistan: Bankruptcy Averted

October 15, 2008 07:30 PM
by Anne Szustek
Financial backing from the Asian Development Bank, the World Bank and other countries is keeping Pakistan in the black. But when a government does go bankrupt, what happens?

In Pakistan, Black is the New Red

The adviser to Pakistani Prime Minister Yusuf Raza Gilani on finance, Shaukat Tareen, has told media that the country has managed to secure funding from other countries and international organizations to cover the $10 billion needed to prevent Pakistan from defaulting.

Tareen told U.K. paper The Daily Telegraph, "An improvement should be visible in our balance of payments from the end of October onwards," expecting that the country is to get at least $3 billion in foreign funding over the next two to three months. "Already the outflow in our foreign reserves is reduced and after November we can build our reserves." In addition, the Department for International Development in London has offered £600 million ($1.03 billion).

Before the influx of funding, Pakistan was gasping to make ends meet. The Pakistani rupee has dropped some 30 percent in value since the start of 2008 and the country’s central bank holds roughly $5 billion in foreign currency.

For comparison purposes, Pakistan’s central bank had some $16 billion in foreign currency reserves as of this past winter.

Skyrocketing oil and fuel prices on top of a government allegedly rife with corruption have been weighing down on Pakistan’s finances. Rising prices for oil and food have pushed up the country’s bills for those commodities by roughly one-third since the start of the year—however the sharp downturn in oil prices on the back of recession fears has mitigated the country's foreign currency outflows somewhat.

Pakistan plans to ask for more foreign aid at a forum in Abu Dhabi next month. Tarin believes that the Gulf Cooperation Council, which includes the United Arab Emirates as well as Saudi Arabia, could loan an additional $2 billion to the country, with a repayment plan from five to 10 years. The fast drop in oil prices is hitting Gulf state sovereign funds however. Plus real estate-heavy Dubai is suffering from a tightening credit market.

Pakistani President Asif Ali Zardari told The Wall Street Journal earlier this month that the country needed some $100 billion in bailout money from other countries. Styling it in terms of bolstering counterterrorism efforts, earlier this month he was quoted as saying in Oct. 6 edition of The Daily Telegraph, “The oil companies are asking me to pay $135 [per barrel] of oil and at the same time they want me to keep the world … and Pakistan peaceful.”

Pakistan’s foreign currency sovereign debt credit rating from Standard & Poor’s is currently CCC+, meaning it is near default.

Historical Context: Past government bankruptcies and courses of action

New York City was on the verge of bankruptcy in 1975, but stayed solvent after the teacher’s union agreed to put $150 million toward the city’s municipal bonds. The situation was so dire that the city had devised a contingency plan to determine which city services would get paid first: the top three being the police and fire departments, respectively, sanitation and public health, and food and shelter aid programs. Mayor Abraham D. Beame drafted a statement set to be released on Oct. 17, 1975, saying that the City of New York was issued a court order to protect its holdings from creditors.

Under Chapter 9 bankruptcy, developed during the Great Depression, municipalities are protected from seizure of assets by creditors and are entitled under U.S. bankruptcy law to negotiate repayment terms. In addition, the 10th Amendment effectively grants immunity to municipalities from bankruptcies, as that body of law is federal in scope, yet not part of the Constitution. As municipalities are under the authority of individual states, any law not enumerated in the 27 amendments is at the discretion of the states.

In reality, when a government goes bankrupt, until the government gets its books in order, public services are cut while taxes and fees go up. Governments often print more money to “cover” debts.

To deal with the government’s default early this decade, in January 2002, Argentina abandoned its peso’s one-to-one peg with the dollar and had all dollar-denominated bank accounts in the country changed over into local currency, exchanged into an “official” rate set at 1.4 pesos to the dollar.

The local currency rapidly devalued. That summer, Argentina stopped fulfilling its debt load.

There was a silver lining in this however: the subsequently cheaper exports resulted in an influx of hard currency, bolstering the Argentinean economy. On top of a successful debt swap in 2005 of $81 billion in defaulted Argentinean bonds in exchange for new debt instruments worth some $0.35 on the dollar, that Latin American economy has largely bounced back.

Neighbor Brazil had similar woes during the mid-1990s. Its public sector was nearly bankrupt after decades of bungling by military regimes. The administration of Brazilian President Itamar Franco implemented the Real Plan, which pegged the local currency, the real, to the U.S. dollar. This tided inflation and increased inflows of foreign currency. A public fiscal readjustment program was developed, which led to growth that helped clear some of the country’s current account deficit and assuage foreign investors’ trepidation about the emerging market economy.

American hedge fund Elliott Associates took a decidedly harsher approach in regards to $11.8 million spent on bad Peruvian public debt. Peru’s government settled in 2000 after a four-year court battle for nearly $56 million.

Less recently, German, British and Italian warships blockaded Venezuelan ports after the country defaulted on its debt in 1902. And in 1881, European countries picked away at the Ottoman Empire’s customs houses after Constantinople, by then known as “the sick man of Europe,” failed to pay up, drained by years of war against Russia.

Related Topic: Iceland braces against bankruptcy

On Oct. 9, Kaupthing, Iceland's largest bank, became the third of the country's top three banks to be taken over by Iceland's Financial Services Authority in the past two weeks, following number two Landsbanki on Tuesday, and the third-largest Icelandic bank, Glitnir. The latter was nationalized on Sept. 29, and taken under receivership on Wednesday, granting the bank a temporary reprieve from paying its debts.

Glitnir also got 5 billion Norwegian krona ($820,000) in liquidity from the Norwegian Banks' Guarantee Fund on Oct. 9. The bank announced the same day that it had begun to sell off its Norwegian operations.

Iceland's stock exchange, the OMX Nordic Exchange Iceland, was shuttered until Tuesday due to what officials called "unusual market conditions."

An emergency parliament measure made for the Icelandic government's creation of "New Landsbanki," a state-owned financial institution that is to hold Landsbanki's domestic deposits.

The fact that most bank accounts in Iceland are in foreign currency rather than krona, owing to foreign customers rushing in to take advantage of high interest rates, is impeding the country’s central bank’s efforts to keep up Iceland's financial institutions.

Since July 2007, the Icelandic krona has dropped more than 46 percent versus the euro, prompting the country to peg its currency to the predominant EU monetary unit and seek a €4 billion (about $5.7 billion) loan from Russia to shore up its reserves and help bolster its currency.

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