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The Moody’s Investors Service on Thursday downgraded Pakistan’s credit rating outlook from stable to negative, stressing that this was driven by Islamabad’s heightened external vulnerability risk and uncertainty around its ability to secure additional external financing to meet its needs.
However, while Moody’s downgraded Pakistan’s credit rating, it affirmed the Government of Pakistan’s local and foreign currency long-term issuer and senior unsecured debt ratings at B3. “Moody’s assesses that Pakistan’s external vulnerability risk has been amplified by rising inflation, which puts downward pressure on the current account, the currency and—already thin—foreign exchange reserves, especially in the context of heightened political and social risk,” read the announcement by the rating agency.
“Pakistan’s weak institutions and governance strength adds uncertainty around the future direction of macroeconomic policy, including whether the country will complete the current IMF Extended Fund Facility (EFF) program and maintain a credible policy path that supports further financing,” it said, adding that the decision to affirm the B3 rating reflects the assumption that Pakistan would conclude the 7th review under the IMF program by the second half of this calendar year and would maintain its engagement with the IMF, enabling it to secure additional financing from other partners.
“In this case, Moody’s assesses that Pakistan will be able to close its financing gap for the next couple of years. The B3 rating also incorporates Moody’s assessment of the scale of Pakistan’s economy and robust growth potential, which will provide the economy with some capacity to absorb shocks,” it said. “These credit strengths are balanced against Pakistan’s fragile external payments position, weak governance and very weak fiscal strength, including very weak debt affordability,” it added.
Moody’s also lowered Pakistan’s local and foreign currency country ceilings to B1 and B3, from Ba3 and B2, respectively. “The two-notch gap between the local currency ceiling and sovereign rating is driven by the government’s relatively large footprint in the economy, weak institutions, and relatively high political and external vulnerability risk,” it said, adding this reflected incomplete capital account convertibility and relatively weak policy effectiveness.
No material changes
According to Moody’s, the ratings committee that determined the downgrade based it primarily on Pakistan becoming increasingly susceptible to event risks. However, it admitted, that the country’s economic fundamentals, including its economic strength, had not materially changed. Nor had Pakistan’s institutions and governance strength materially changed, it said, adding the financial strength, including its debt profile, had not materially changed.
“Moody’s expects Pakistan’s current account to remain under significant pressure, on the back of elevated global commodity prices through 2022 and 2023,” it said, adding the deficit had widened to $13.8 billion from July through April 2021, compared to a deficit of $543 million in the same period last year. “In the absence of an equivalent inflow in the financial account, the rapid widening of the current account deficit has led to a large drawdown of the foreign exchange reserves. According to data from the IMF, Pakistan’s foreign exchange reserves have declined to $9.7 billion at the end of April 2022, which is sufficient to cover less than two months of imports. This compares with the $18.9 billion of reserves at the end of July 2021,” it said, adding that it projected the current account deficit to come in at 4.5-5% of GDP for fiscal 2022. “As global commodity prices decline gradually in 2023 and as domestic demand moderates, Moody’s expects the current account deficit to narrow to 3.5-4% of GDP,” it added.
“The larger current account deficits underscore the need for Pakistan to secure additional external financing, especially given its very low foreign exchange reserves,” it said, stressing the continuation of the IMF program was vital for economic stability. Meanwhile, the ratings agency warned the “the balance of risks is on the downside,” as an agreement with IMF could take longer than expected.
“Recent moves by the government to raise fuel prices signal its commitment to addressing issues raised by the IMF. Still, political and social challenges will complicate the government’s efforts to agree on and implement further reforms, such as revenue raising reforms,” it said, warning that if Islamabad cannot secure additional financing later this year, there would be heightened risk of a balance of payments crisis. “Pakistan’s rising external vulnerability risk has been amplified by rising inflation, particularly in the context of heightened political and social risks,” it warned. “In April 2022, inflation reached 13.4% year-on-year, with particularly high inflation in food and energy, which account for a very large share of the most vulnerable households’ budgets,” it added.
Moody’s also warned that political uncertainty in Pakistan would likely remain high, noting that “political parties will find it difficult to continually enact significant revenue-raising measures in the run-up to the [2023 general] elections, especially in a high inflation environment.” It noted that rising interest rates would likely also constrain the government’s policy choices, “especially since interest payments already absorb more than 40% of revenue.”
The ratings agency projected Pakistan’s real GDP growth to slow to 4.2% in fiscal 2023, moderately lower than the government’s projections. “This compares with growth of 6% in fiscal 2022. The moderation in economic activity reflects the drag on domestic demand from rising inflation and a tightening in monetary policy by the State Bank of Pakistan,” it said, adding it expected the real GDP to pick up gradually, reaching 4.5-5% over fiscal 2024 and 2025.
“Given a very narrow revenue base, Pakistan’s government debt as a share of revenue is very high at around 560% in fiscal 2021. Moody’s expects this ratio to remain elevated at 550-590% over fiscal 2022 to 2024, well above the 290% for the median B-rated sovereign. As mentioned, the sovereign also has very weak debt affordability—one of the weakest among Moody’s rated sovereigns,” it added.
According to Moody’s Pakistan’s rating could be upgraded again if the country’s external vulnerability risks decreased materially and durably. “This could come from access to material external financing that significantly raises foreign exchange reserves … with credible commitment from the government to follow through the implementation of economic reforms,” it said, adding fiscal consolidation, including through implementing revenue-raising measures, could also boost the rating. However, it warned, the rating could be downgraded further if there were any more deterioration in Pakistan’s external position that threatens external repayment capacity and balance of payments stability. “This could come from protracted negotiations with the IMF, resulting in delays in securing additional financing from IMF or other sources beyond this year,” it warned. “An increase in social and political risk that disrupted policymaking and undermined Pakistan’s ability to secure financing would also be negative for the rating,” it added.
The PTI, which was in power through the first half of April, has declared the downgrading a reflection of the incumbent government’s policies.