Analysis

A commentary on Bloomberg’s default risk list | By Dr. Atiq-ur-Rehman

Bloomberg has published a list titled as “Countries with Highest Risk of Default in 2022. This list is based on four indicators: Government Bond Yield, Credit Default Risk Swap, Interest Payment to GDP ratio, and Government Debt to GDP ratio.


This list places Pakistan at number 4 with respect to the default probability. This short article discusses three important questions related to this list.


First – who is responsible for such a bad ranking of the country in this list, second – is it a true reflection of the true probability of default, and third – what are the implications of the release of this list!


With regard to the first question, as I have mentioned above, the list is based on four indicators, and the State Bank of Pakistan is solely responsible for the bad position of the country in this list.

The first indicator is government bond yield which is the interest rate on investment in government debt instruments.

The interest rate on government securities is directly related to the policy rate decided by the Monetary Policy Committee of the State Bank of Pakistan.

They have sole authority in deciding the interest rate and there is no institution having a legitimate position to interfere in the decision of interest rate.

For example, from March-May 2020, the SBP reduced the policy rate from 13.25% to 7% and there was no institution to protest such a huge reduction in the interest rate despite the fact that the inflation at the time was higher than the policy rate.

During the last few months, the SBP has increased the policy rate from 7% to 15% without any demand for an increase from the banking sector or any other stakeholder.

The decision of policy rate and associated government bond yield is the sole discretion of SBP with no interference from any other institution or authority.

The question arises as to what are the parameters on which SBP’s decision about policy rate is based.

I have discussed this in a number of newspapers and academic articles. It is clearly visible in the monetary policy statements as well, that the interest rate is increased with the aim to control inflation. SBP thinks that if they increase the interest rate, inflation will go down.

Therefore, they jacked up the policy rate from 7% to 15%. Here, the fault of the SBP is that the SBP is having Absolutely No evaluation report on the effectiveness of the monetary policy. There are very large costs associated with the policy rate.

In the budget for the current financial year, 3.49 trillion have been reserved for the interest payment on domestic debt, making it the single largest consumption head in the budget.

Besides the actual payments and resultant bad rank in government bond yield, this allocation is giving a very bad rank to the country in the indicator ‘interest to GDP ratio’.

If there are so heavy costs of a policy decision, there must be an evaluation report on the effectiveness of the decision.

Once I challenged the Head of the Monetary Policy Department of the SBP in a public forum to present any evaluation report if it exists, and my respectable colleague was unable to reply.

The high policy rate is not only responsible for high government bond yield, it is also responsible for the high interest to GDP ratio.

During the last two years of the PTI government, the government frequently claimed that they had a surplus primary budget, which means the income exceeds the expenditure if we exclude the mark-up payments.

Despite this, the government borrowed very extensively and this borrowing was only to finance the interest on existing debts.

I mean to say the debt accumulation during the last two years of the PTI government is only a result of interest payments which were a result of the choice of the policy rate.

Therefore, the answer to our first question is, that the State Bank of Pakistan is solely responsible for the bad rank of the country in the default risk list. The second associated question is: is it a true reflection of the default risk?

The answer is no! Although the methodology used for the calculation of this list is not explained in the publicly available blogs, the indicators included in this calculation are based on domestic accounts only.

The actual default risk comes from the balance of external accounts. For example, the default of Sri Lanka as a result of the crisis of external payments.

Without having indicators related to external accounts, the list cannot reflect the actual probabilities of default. The third associated question is: what are the implications of this list?

Although the list is not a true reflection of the probability of default, this gives a very bad message about the economic environment.

Nobody goes into the details of the methodology used in the compilation of this list, it would be taken as a reliable list since it is coming from Bloomberg.

The investor will take it as a negative signal and it would be very less probable for the investor to invest in a country having the fourth highest probability of default.

The writer is Director, Kashmir Institute of Economics, Azad Jammu, and Kashmir University.

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