Pakistan External Debt - 18-September-2008

8/14/2019 Pakistan External Debt - 18-September-2008

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ELIXIR SECURITIES PAKISTAN

Elixir Securities Pakistan (Pvt) Ltd.

An InvestFin S S.A. group company

Executive Summary

Credit Default Swap (CDS) spread on Pakistans 5-Year Eurobond hasincreased from 675bps to 1,000bps since the beginning of August 2008. The

gap between CDS spreads of 5 and 10-Year bonds is also shrinking

With the rise in CDS spreads, the issues related to the sustainability andcarrying capacity of external debt have become necessary to address. We,

nonetheless, believe that CDS spread is not a very strong indicator of

Pakistans external debt carrying capacity

According to the latest data available from SBP, the stock of PakistansTotal External Debt and Liabilities (TEDL) stands at USD46.3bn. Although

this amount seems hefty, TEDL to GDP ratio has reduced substantially from

59.1% of GDP in FY98 to 29.3% in FY08

In FY00, the total burden of debt servicing (actual paid amount plus rolledover amount) was USD7.8bn, which has slid down significantly to USD3.5bn

in FY08 (CAGR: -9.6%)

Moreover, despite the upcoming payments for Eurobonds and rescheduledParis Club debt, the estimated debt servicing burden in FY09 is expected to

range between 18-20% of export earnings, compared to more than 80% in

FY01

In addition, major debt sustainability indicators reveal that Pakistan is in arelatively better position than late 90s, when GoPs debt carrying capacity

was quite weak

GoPs privatization plan in FY09 is a feasible option to further reduce thestock of external debt and would help in streamlining the future debt

servicing burden. However, given the current international financial crunch

and domestic economic woes, we think that privatization plan may either

encounter subdued interest from prospective buyers or highly undervalued

bids

Nonetheless, having a good debt carrying capacity does not in any wayundermine the importance of external sector management. The current

external sector woes have already necessitated immediate policy tweaking,

especially towards import substitution, export promotion and squeezing the

domestic demand

Pakistans External Debt Position:

How Grim is the Situation?

September 18, 2008

In-depth Report

Haider HussainEconomist

(92-21) 242 [email protected]

Economy


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Pakistans External Debt Position: How Grim is the Situation?

2ELIXIR SECURITIES PAKISTAN

September 18, 2008

Introduction

Credit Default Swap (CDS) spreads on Pakistans Eurobonds have increased sharply

since the beginning of August 2008. At the end of July 2008, CDS spread on 5-Year

sovereign bond stood at 655bps, which has aggressively increased to 1,000bps on 10th

September 2008. This indicates that the market is attaching a higher probability ofdefault on GoPs medium term debt.

Furthermore, between June 2007 and July 2008, the difference between CDS spreads

of 5 and 10-Year Eurobonds remained around 100bps, on average. However, this

difference has shrunk to 42.5bps during August-September 2008, which signals the

market perception that defaulting on GoPs long term debt is not seen very differently

from defaulting on short term debt.

CDS Spreads on 5 and 10-Year Eurobonds

Source: SBP, Elixir

With the rise in CDS spreads, the issues related to the sustainability and carrying

capacity of Pakistans external debt have become necessary to address. Although the

importance of managing external sector cannot be overemphasized, we are of the view

that Pakistan is still in a position to carry the current levels of external debt.

Moreover, we believe that CDS spread on Eurobonds is not a very strong indicator of

Pakistans capacity to sustain the existing external debt. We base this assertion on the

fact that the upcoming payment of Eurobond in February 2009 is around USD662.7mn,

which is only 2-4% of our projected export earnings in FY09.

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September 18, 2008ELIXIR SECURITIES PAKISTAN

3

Pakistans External Debt Profile

According to the latest data available from SBP, the stock of Pakistans Total External

Debt and Liabilities (TEDL) stands at USD46.3bn. Within this TEDL, medium and long

term debts constitute around 85% while the sovereign public bonds comprise a meager

6% of TEDL. Although USD46.3bn seems a hefty amount at first sight, TEDL to GDP ratiohas reduced substantially from 59.1% of GDP in FY98 to 29.3% in FY08.

Pakistan's External Debt and Liabilities

USD mn FY98 FY08 CAGR

External Debt 30,418 44,467 3.9%

Public 25,876 40,047 4.5%

Medium and long term(more than 1 year) 25,703 39,334 4.3%

Paris club 10,264 13,928 3.1%

Multilateral 11,988 21,451 6.0%

Other bilateral 592 1,129 6.7%

Euro/Sukuk/Global bonds 628 2,650 15.5%

Military debt 1,006 41 -27.4%Commercial Loans/credits 1,225 120 -20.7%

Short Term (less than 1 year) 173 713 15.2%

Private 3,127 2,612 -1.8%

IMF 1,415 1,337 -0.6%

External Liabilities 3,506 1,817 -6.4%

Total External Debt and Liabilities (TEDL) 33,924 46,284 3.2%

TEDL to GDP Ratio 59.1% 29.3% -

Source: SBP, Elixir

Part of this considerable reduction in TEDL to GDP ratio is attributed to more than 5%

average annual growth of GDP between FY98 and FY08. Moreover, GoP has alsomanaged to retire military and commercial debts as well as private loans and foreign

exchange liabilities (e.g. special USD bonds) during the said period. Nevertheless,

during FY07 and FY08, Pakistans TEDL has witnessed an accumulation of around

USD5.8bn, which was mainly on account of misbalancing PKR/USD parity.

Structure of External Debt, FY08

Source: SBP, Elixir

Sovereign

Bonds, 6%

Multilateral,

48%

Other Debt,

15%Paris Club,

31%


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September 18, 2008

Debt Servicing Burden has declined substantially

over the years

In terms of debt servicing (principal payment + interest), Pakistans economy has

strengthened considerably during FY00-08. In FY00, the total burden of debt servicing

(actual paid amount plus rolled over amount) was USD7.8bn, which has slid down

significantly to USD3.5bn in FY08 (CAGR: -9.6%).

This reduction in debt servicing burden is attributed mainly to the re-profiling of Paris

Clubs debt, significant write-offs of the US bilateral debt, prepayment of an

expensive debt (USD1.1bn) and acquisition of new loans on concessional basis.

Servicing of External Debt and Liabilities

USD bn Actual Paid Rolled Over / Rescheduled Total

FY00 3.76 4.08 7.84

FY01 5.10 2.80 7.90

FY02 6.33 2.24 8.57

FY03 4.35 1.91 6.26

FY04 5.27 1.30 6.57

FY05 2.97 1.30 4.27

FY06 3.12 1.30 4.42

FY07 2.98 1.30 4.28

FY08 2.20 1.30 3.50

Source: MoF, SBP

Going forward, the declining trend of debt servicing burden is unlikely to continue due

to the start of payments for Paris Clubs rescheduled non-ODA (non-development)

debt, Eurobond payments (FY09: USD662.7mn, FY10: USD724.9mn) and GoPs

deteriorating external account position.

Total Debt Servicing (Actual + Rolled over)

Red line presents SBPs projection

Source: SBP, Elixir

Nevertheless, our comparison of debt servicing and export earnings shows that, even

after accounting for these developments, the estimated debt servicing burden in FY09

is expected to range between 18-20% of export earnings, compared to more than 80%

in FY01.

3.5

4.5

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6.5

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FY01

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USD bn


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5

Debt Sustainability Indicators show signs of respite

Analysis of the debt sustainability indicators reveal that Pakistans external debt

position is in a much better shape than it was ten years ago. Both TEDL to Export

Earning and TEDL to Current Foreign Exchange Earning Ratios have declined sharply

since FY99 and become stable from FY06 onwards. We believe that although current

foreign exchange earnings (earnings from exports, services, income and private

transfers) are likely to remain lackluster in FY09, situation would not become as bleak

as witnessed in late 90s.

TEDL to Current Foreign Exchange Earnings Ratio TEDL to Export Earnings Ratio

Foreign Exchange earnings refer to the earnings on Current Account (exports, remittances, interest & dividend incomes)

Source: SBP, Elixir

Similarly, as discussed earlier, TEDL to GDP Ratio has also declined significantly during

the period under review; though the much anticipated slippage in GDP growth in FY09

would increase this ratio slightly.

Foreign exchange accumulation has been the main factor behind the increase in Forex

Reserve to TEDL Ratio from 5.9% in FY98 to 38.6% in FY07. However, significant

reserve depletion in recent times, combined with the accumulation of USD5.8bn

external debt has caused this ratio to decline crisply to 20.3% in FY08. This decline can

be expected to continue for a while until any external financing package comes to

rescue.

TEDL to GDP Ratio Forex Reserves to TEDL Ratio

Source: SBP, Elixir

100%

150%

200%

250%

300%

350%

FY98

FY00

FY02

FY04

FY06

FY08

200%

250%

300%

350%

400%

450%

500%

FY98

FY00

FY02

FY04

FY06

FY08

0%

5%

10%

15%

20%

25%

30%

35%

40%

FY98

FY00

FY02

FY04

FY06

FY08

25%

35%

45%

55%

65%

75%

FY98

FY00

FY02

FY04

FY06

FY08


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September 18, 2008

Interest Payments on External Debt: A Favorable

Picture

During FY98-08, Pakistans interest payments on external debt have witnessed a

considerable decline (except one hike in FY07). As percentage of GoPs tax and non-

tax revenues, external interest payments have decreased from 7.3% in FY98 to lessthan 3.0% in FY08.

Similarly, interest payments to current foreign exchange earnings ratio has also

declined gradually from 5.3% in FY98 to 1.7% in FY08, thanks to post 9/11 inflow of

remittances and improved inflows on account of goods and services exports.

Analysis of External Interest Payments

Source: MoF, Elixir

Going forward, acquisition of fresh debt in FY09 to support the deteriorating external

account, coupled with the slowdown in current foreign exchange earnings, may halt

this declining trend. However, we believe that it is highly unlikely that the situation

experienced in late 90s would repeat itself.

0.0%

1.0%

2.0%

3.0%

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5.0%

6.0%

7.0%

8.0%

FY

98

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99

FY

00

FY

01

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

Interest Payment to B udgetary Revenues

Interest Payment to Current Foreign Exchange Earnings


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7

Debt Reduction through Privatization: Feasible

though Painstaking

On August 26, 2008, Privatization Commission (PC) approved the privatization of

OGDCL and this process is anticipated to be completed anytime in FY09. In this

regards, Privatization Commission (PC) Ordinance 2000 makes it mandatory to use 90%

of any privatization proceed for debt retirement (domestic and/or external), while the

remaining 10% for poverty alleviation. Therefore, any prospective sale of GoPs

shareholding of OGDCL will give the government enough room to support the upcoming

debt acquisitions and current debt servicing.

However, the debt retirement clause of PC Ordinance 2000 will not be applicable in

case OGDCL sells off one of its premier field Qadirpur. Even then, the sell off could

line up around PKR95bn dividend income to GoP (from OGDCL), which is substantially

higher than what is expected in FY09 budget (PKR40bn).

Besides OGDCL, a number of other public sector entities have been planned to be

privatized during FY09. These include GDR of Kot Addu Power Company (KAPCO), Small

and Medium Enterprise (SME) Bank, 90% shares of Hazara Phosphate Fertilizers Limited

(HPFL), National Power Construction Company (NPCC), Heavy Electrical Complex (HEC)

and Pakistan Tourism Development Corporation (PTDC)s Motels & Restaurants.

Nevertheless, keeping in view the current global financial turmoil and domestic

economic woes, we believe that finding prospective buyers will be a painstaking job

for GoP at this point in time. In our view, either the GoP will be unable to attract

buyers, or the bids will be highly undervalued.


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September 18, 2008

Bottom Line

Our analysis indicates that Pakistans external debt is still within sustainable and

manageable limits. In terms of external debt, we are in a much better position than

late 90s. Although the recent escalation of external account pressures may further

hamper the inflow-outflow balance, acquisition of fresh debt to support the balance ofpayment (which has become quite necessary) would not significantly hit the external

debt carrying capacity of GoP in FY09. Furthermore, despite the highly probable

economic slowdown in FY09, we would not be in the grim situation as in the late 90s.

In our view, we have still not reached the point where the stock of external debt poses

a serious threat to economic stability.

Having stated that, we believe that external debt is only one of the indicators of the

problems GoP is facing regarding the external account and these problems are much

broader in sense. The current external sector woes, including sluggish exports, higher

oil import bill, depletion of forex reserves and declining foreign private investment

have more than necessitated the immediate policy tweaking, especially towards

import substitution, export promotion and squeezing domestic demand.

Moreover, we are of the view that having a good debt carrying capacity does not in any

way undermine the importance of external sector management. The debt acquisition

policies, besides financing the balance on payment, should also focus on the

investment in the commodity-producing sectors; as continuing the debt financing of

balance of payment is certainly undesirable beyond FY09.


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ELIXIR SECURITIES PAKISTAN

The report has been prepared by Elixir Securities Pakistan (Pvt.) Ltd. (Elixir Pakistan) The information and opinions contained herein has beencompiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. Such information has not beenindependently verified and no guaranty, representation or warranty, express or implied is made as to its accuracy, completeness or correctness. Allsuch information and opinions are subject to change without notice. This document is for information purposes only, descriptions of any company orcompanies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as, an offer, orsolicitation of an offer, to buy or sell any securities or other financial instruments.

Elixir Pakistan may, to the extent permissible by applicable law or regulation, use the above material, conclusions, research or analysis in which they

are based before the material is disseminated to their customers. Not all customers will receive the material at the same time. Elixir Pakistan, theirrespective directors, officers, representatives, employees and/or related persons may have a long or short position in any of the securities or otherfinancial instruments mentioned or issuers described herein at any time and may make a purchase and/or sale, or offer to make a purchase and/or saleof any such securities or other financial instruments from time to time in the open market or otherwise. Elixir Pakistan may make markets in securities orother financial instruments described in this publication, in securities of issuers described herein or in securities underlying or related to such securities.Elixir Pakistan may have recently underwritten the securities of an issuer mentioned herein. This document may not be reproduced, distributed orpublished for any purposes.

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Copyright 2008, Elixir Securities Pakistan (Pvt.) Ltd.

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Pakistan External Debt - 18-September-2008

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