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The Moody’s Investors Service on Tuesday downgraded Pakistan’s sovereign credit rating to ‘Caa3’—the lowest in 30 years—citing the worsening liquidity situation as “significantly raising default risks.”
Pakistan is currently in the midst of lengthy negotiations with the International Monetary Fund (IMF) to secure the release of a $1 billion tranche of a $6.5 billion bailout package, originally approved in 2019. The global lender has repeatedly shifted goalposts during talks, demanding ever-greater prior conditions from the cash-strapped nation to revive a program seen as key to shoring up its depleting foreign exchange reserves.
According to a statement from Moody’s, it changed Pakistan’s outlook from negative to stable alongside the downgrade of its credit rating. “In particular, the country’s foreign exchange reserves have fallen to extremely low levels, far lower than necessary to cover its import needs and external debt obligations over the immediate and medium term,” it said, adding that while recent taxation measures would help cover some immediate needs, weak governance and heightened social risks impede Pakistan’s ability to continually implement the range of policies required to secure large amounts of financing and decisively mitigate risks to the balance of payments.
It said that the “stable” outlook reflected its assessment that the pressures facing Pakistan were consistent with a Caa3 rating level, with broadly balanced risks.
Default risks
On Pakistan’s default risk, Moody’s said it should reduce—“potentially to a level consistent with a higher rating—once the IMF program was revived and related financing was secured. “However, in the current extremely fragile balance of payments situation, disbursements may not be secured in time to avoid a default,” it warned, adding that once the current IMF program ended in June 2023, there were few viable options for Pakistan to finance its external payments. “Continued IMF engagement, including beyond the current program, will likely help to support additional financing from other multilateral and bilateral partners, which can reduce default risk if this is achieved urgently and without further raising social pressures,” it said.
Justifying the rationale for the downgrade to Caa3, the service said Pakistan’s liquidity and external vulnerability risks had risen further since the last review in October 2022. “Pakistan’s foreign exchange reserves have declined to a critically low level, sufficient to cover less than one month of imports. Amid delays in securing official sector funding, risks that Pakistan may not be able to source enough financing to meet its needs for the rest of fiscal 2023 (ending June 2023) have increased,” it said, adding that liquidity and external vulnerability risks would remain elevated, especially as prospects of materially increasing foreign exchange reserves were low.
External financing
Estimating Pakistan’s external financing needs for the rest of the ongoing fiscal year to be around $11 billion, Moody’s said this would require the country to secure financing from the IMF and other multilateral and bilateral partners. This, it stressed, required the IMF program to be revived. “At the same time, the government will also need to obtain the rollover of the $3 billion China SAFE deposits and secure $3.3 billion worth of refinancing from Chinese commercial banks for the rest of this fiscal year. Of this $3.3 billion, Pakistan has already received a deposit of $700 million from the China Development Bank on Feb. 24,” it said.
While expressing cautious optimism over Pakistan meeting its external payments requirements, the agency warned that the country’s liquidity and external position would remain extremely fragile next year. “Pakistan’s financing options beyond June 2023 are highly uncertain. It is not clear that another IMF program is under discussion and if it does happen, how long the negotiations would take and what conditions would be attached to it,” it added.
The investors’ service also warned that headline inflation was likely to rise further as energy prices increased in tandem with the removal of energy subsidies.