July 10, 2023 (MLN): Fitch Ratings has upgraded Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CCC’ from ‘CCC-‘.
KEY RATING DRIVERS
Easing External Financing Risks: The upgrade reflects Pakistan’s improved external liquidity and funding conditions following its Staff-Level Agreement (SLA) with the IMF on a nine-month Stand-by Arrangement (SBA) in June.
Fitch expects the SLA to be approved by the IMF board in July, catalyzing other funding and anchoring policies around parliamentary elections due by October.
Nevertheless, programme implementation and external funding risks remain due to a volatile political climate and large external financing requirements.
IMF-Driven Reforms: Pakistan has recently taken measures to address shortfalls in government revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate, including import financing restrictions.
These issues held up the last three reviews of Pakistan’s previous IMF programme, before its expiry in June.
Most recently, the government amended its proposed budget for the fiscal year ending June 2024 (FY24) to introduce new revenue measures and cut spending, following additional tax measures and subsidy reforms in February.
The authorities appeared to abandon exchange-rate management in January 2023, although guidelines on prioritizing imports were only removed in June.
Implementation Risks: Pakistan has an extensive record of going off-track on its commitments to the IMF.
Fitch understands the government has already made all the required policy actions under the SBA. Nevertheless, there is still scope for delays and challenges to implementation as well as new policy missteps ahead of the October elections and uncertainty over the post-election commitment to the programme.
New Funding Unlocked: IMF board approval of the SBA will unlock an immediate disbursement of $1.2 billion, with the remaining $1.8bn scheduled after reviews in November and February 2024.
Saudi Arabia and the United Arab Emirates have committed another $3bn in deposits, and the authorities expect $3-5bn in other new multilateral funding after the IMF agreement.
The SBA should also facilitate disbursement of some of the $10bn in aid pledges made at the January 2023 flood relief conference, mostly in the form of project loans ($2bn in the budget).
Overall Funding Targets Ambitious: The authorities expect $25bn in gross new external financing in FY24, against $15bn in public debt maturities, including $1bn in bonds and $3.6bn to multilateral creditors.
The government funding target includes $1.5bn in market issuance and $4.5bn in commercial bank borrowing, both of which could prove challenging, although some of the loans not rolled over in FY23 could now return.
$9bn in maturing deposits from China, Saudi Arabia and the UAE will likely be rolled over, as in FY23.
Narrower External Deficit: Pakistan’s current account deficit (CAD) has narrowed sharply, driven by earlier restrictions on imports and FX availability, tighter fiscal and economic policies, measures to limit energy consumption and lower commodity prices.
Pakistan posted current account surpluses in March-May 2023, and we forecast a CAD of about $4bn (1% of GDP) in FY24, after USD3 billion in FY23 and over $17bn in FY22.
Fitch’s forecast CAD is lower than the $6bn in the budget, on the assumption that not all of the planned new funding will materialise, constraining imports.
External Deficit Risks: The CAD could widen more than we expect, given continued reports of import backlogs, the dependence of the manufacturing sector on foreign inputs, and reconstruction needs after last year’s floods.
Nevertheless, currency depreciation could limit the rise, as the authorities intend for imports to be financed through banks, without recourse to official reserves.
Remittance inflows could also recover after partly switching to unofficial channels to benefit from more favourable parallel market exchange rates.
The ‘CCC’ Long-Term Foreign-Currency IDR also reflects the following factors:
Reserves Still Low: Liquid net FX reserves of the State Bank of Pakistan have hovered around $4bn since February 2023, or less than a month of imports, down from a peak of more than $20bn at end-August 2021.
The collapse in reserves reflected large CADs, external debt servicing and earlier FX intervention by the central bank. We expect a modest recovery for the rest of FY24 on new external financing flows, although these flows will also lead to a renewed widening of the CAD.
Volatile Politics: Protests by supporters of former prime minister Imran Khan and his PTI party sharply intensified in May as Mr Khan was briefly arrested on corruption charges, culminating in attacks on army facilities.
In the ensuing crackdown, a large number of PTI members were arrested, with several high-ranking PTI politicians quitting politics. Nevertheless, the enduring popularity of Mr Khan and PTI create policy uncertainty around elections.
Fiscal Deficits Remain Wide: We expect the consolidated general government (GG) fiscal deficit to widen to 7.6% of GDP in FY24, from an estimated 7.0% in FY23, driven by higher interest costs on domestic debt, which accounts for the difference between our forecast and a GG deficit of 7.1% of GDP in the revised FY24 budget statement (with a lower figure of 6.5% in the medium-term fiscal framework).
Fiscal consolidation will drive a slight improvement in our forecast GG primary deficit to 0.1% of GDP in FY24, from 0.5% of GDP in FY23.
High, Stable Debt Level: The GG debt/GDP of 74% at FYE23 is in line with the median for ‘B’, ‘C’ and ‘D’ rating category sovereigns and debt dynamics are broadly stable owing to high nominal growth over the medium term. Nevertheless, debt/revenue (over 600%) and interest/revenue (nearly 60%) are far worse than that of peers.
Government Considering Bilateral Maturity Extension: The finance minister recently said that Pakistan would seek maturity extensions on loans by non-Paris club bilateral creditors, while reaffirming the government’s commitment to timely debt service.
Fitch understands that such maturity extensions would mostly relate to loans and deposits by China, Saudi Arabia and the UAE, which are already regularly rolled over.
In 2022, the prime minister and former finance minister raised the possibility of seeking debt relief from non-commercial creditors, including the Paris Club, but the authorities now appear to have moved away from this. Should Paris Club debt treatment be sought, Paris Club creditors are likely to require comparable treatment for private external creditors in any restructuring.
ESG – Governance: Pakistan has an ESG Relevance Score (RS) of ‘5’ for both political stability and rights and for the rule of law, institutional and regulatory quality and control of corruption.
These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Pakistan has a WBGI ranking at the lower 22nd percentile.
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
– Public Finances: The increasing likelihood of default, for example, renewed deterioration in external liquidity conditions that could result from delays in IMF disbursements, or indications that the authorities are considering debt restructuring.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
– Public Finances: Strong performance against IMF programme conditions, ensuring continued availability of funding.
– External Finances: Rebuilding of foreign-currency reserves and further easing of external financing risks.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Pakistan a score equivalent to a rating of ‘CCC+’ on the Long-Term Foreign-Currency IDR scale.
However, in accordance with its rating criteria, Fitch’s sovereign rating committee has not utilized the SRM and QO to explain the ratings in this instance. Ratings of ‘CCC+’ and below are instead guided by the rating definitions.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR.
Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
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Posted on: 2023-07-10T16:40:57+05:00