Pakistani Debt Default Concerns Rise

Pakistan, whose credit default swaps (CDS) have more than doubled since October 2007 because of growing political uncertainty and tension between rival parties, is expected to join Markit's iTraxx Asia ex-Japan Index of credit-default swaps. This follows a dramatic increase in demand to trade on the credit default swap contracts for Pakistan, reports Bloomberg.com. Pakistan is also slated to join the 20- member sub-index for non investment-grade governments and companies.

Credit-default swaps are an indicator of the cost of bond insurance that varies with the risk of bond default. Credit default swaps are usually bought by bond holders from credit insurance companies like Ambac, FGIC, and MBIA. These insurers reimburse bondholders in case the bond issuing companies or governments default. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year. This is the first time Pakistan is being included in an index of bond default swaps since it got a B+ rating from S&P and started raising capital through borrowing in the international commercial debt market. Prior to this, Pakistan was considered such a high-risk that it could only borrow from IMF, World Bank, Asian Development bank and other similar institutions that lend to the poor nations deemed not credit-worthy. Pakistan did not have access to the commercial credit markets in the 1990s. Pakistan is becoming more active in raising money in global capital markets despite its volatile politics. Last month the country said it was considering issuing a sovereign bond issue, although it has yet to provide further details behind its plan.

It should be noted that the international and the US bond markets have been seriously unsettled recently due to the sub-prime mortgage backed securities crisis. Just yesterday, the Federal Reserve had to bail out Bear Stearns in the United States. Still, the value of Bear Stearns stock dropped by a half in a single day. There are serious concerns about the default of collateralized debt obligations (CDOs) and the ability of the bond insurers such as Ambac to protect the holders of such securities. This has led to a severe credit crunch in which the major banks are unwilling to loan money to each other.