Pakistan recently met a $1 billion bond payment with the maturity date of 5 December 2022. In doing so, the nation avoided default. However, the StarMine Sovereign Risk model shows that Pakistan is still in a difficult situation and has been so for several years. The situation became worse in 2022 according to the model. Here, we analyse the main drivers of Pakistan’s sovereign risk.
- The StarMine Sovereign Risk Model evaluates a wide array of macroeconomic, market-based and political data to estimate the probability that a sovereign government will default on its debt.
- We use the StarMine Sovereign Risk Model to analyse the contributing factors that have culminated in Pakistan’s credit risk crisis over the past five years, focusing on variables such as inflation, political risk, government consumption over private consumption, GDP per capita and reserves over imports.
- By using the StarMine Sovereign Risk Model, this analysis shows how despite Pakistan’s situation improving slightly in 2022, it remains in the top five countries with the highest risk of sovereign default.
For more data-driven insights in your Inbox, subscribe to the Refinitiv Perspectives weekly newsletter.
The StarMine Sovereign Risk Model (StarMine SR) evaluates a wide array of macroeconomic, market-based and political data to estimate the probability that a sovereign government will default on its debt. It covers over 130 countries calculating the probability of default (PD) within six different time horizons.
The (StarMine SR) breaks down the risk into short- and long-term components, which are percentile ranks over all countries scored, with values ranging from 1 to 100, where the value 1 represents the highest risk.
The long-term component incorporates information from the variables that change slowly and reflect the long-term financial health of the country. In contrast, the short-term component reflects information from the faster-moving variables. We find that a country can stay solvent for some time with unhealthily long-term financials until a short-term component “trigger” pushes it over the edge.
We used StarMine SR to analyse the last five years of the model output for Pakistan.
As shown in Figure 1(a), Pakistan had a one-year PD of around 10 percent until the middle of 2022, when it increased considerably. The impact of the devastating floods in 2022 further deepened the difficult situation the country has been in.
StarMine SR has classified Pakistan as junk grade (below BBB-) for several years, as shown in Figure 1(b), indicating a country with a high risk of default. In the last three months, the quality rating increased slightly, but the country continues to be in a dangerous default zone.
A country in crisis
By studying the short- and long-term scores of the model, as shown in Figure 1(c), one notices that the long-term score shows a reasonably steady situation over time, but with a low score. By its nature, the short-term component fluctuates more than the long-term component. However, if long- and short-term scores both show low values, the overall score is also low, and this is an indication of a country in a crisis.
We can see that for most of the last five years, Pakistan has been in the bottom quintile for the overall, long- and short-term scores. As of 30 November 2022, its overall score was 4, the long-term component score was 9 and the short-term score was 3.
Figure 1. Pakistan (a) 1-year probability of default, (b) letter rating, (c) overall, short- and long-term scores, as a function of time for the last five years.
In Table 1, we list the variables used as inputs into StarMine SR, their scores from 1 to 100, and a description of how that variable is impacting the model’s output for Pakistan.
We coded in dark red, red and yellow the variables that have a score below 11, 26 and 51 respectively. Variables with a score of 51 and above are marked in green. The variables with scores of five or lower are:
- Reserve level and variation: low values mean low and highly fluctuating reserves. The value of this variable has decreased substantially in 2022.
- GDP growth: in recent months, the annual GDP growth was -12 percent, which of course is a very low number.
- Imports of goods and services over GDP: this quantity decreased by about 20 percent in 2022 when compared with 2021 levels. The lower this value, the greater the risk, according to the model.
- The purchasing power parity ratio: its value increased considerably in recent times. The larger the distance from 1, the greater the risk, since this means that the currency devaluation and inflation are not moving in tandem with each other.
The evolution of these variables in the last five years is shown in Figure 2.
Table 1. Model variable values for Pakistan as of 11/30/2022. Scores vary from 1 to 100, with 1 being the riskiest level.
Figure 2. The last five years of (a) Pakistan’s reserves level and variation, (b) annual GDP growth, (c) imports of goods and services over GDP and (d) the purchasing power parity ratio.
From Table 1, we also see that the following variables are also contributing factors to the Pakistani crisis: inflation, political risk, government consumption over private consumption, GDP per capita and reserves over imports.
Which countries are most at risk of sovereign default?
Table 2 displays the five countries with the highest risk (as of 30/11/2022) as measured by StarMine SR.
Based on this table, Gambia, Sierra Leone, and Ghana are also in a very difficult situation. Sri Lanka defaulted in May 2022 and continues to be in serious trouble.
Table 2. Top five countries with the highest risk of sovereign default based on StarMine SR as of November 30, 2022.
In summary, StarMine SR had been classifying Pakistan as very high risk for several years, and although the country’s situation improved slightly in the last three months, Pakistan continues to be in a very tough spot.