Hong Kong: Fitch Ratings has acknowledged Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘CCC’. Fitch typically does not assign Outlooks to sovereigns with a rating of ‘CCC+’ or below.
To affirm the rating, the following key drivers were taken into consideration.
External Risks Easing: The ‘CCC’ rating reflects high external funding risks amid high medium-term financing requisites, despite some stability indicators and Pakistan’s strong performance on its current Stand-by Arrangement (SBA) with the International Monitory Fund (IMF).
The rating agency also expressed expectation about holding of elections in February next year, followed by another IMF programme after the competition of the SBA in March 2024; however, adding that there was still the risk of delays and uncertainty around Pakistan’s ability to do this. The elections could endanger the durability of recent reforms and leave room for renewed political volatility.
Successful IMF Review: In November, Pakistan and the IMF reached a staff-level agreement (SLA) on the first review over the nine-month-long stand-By Agreement, which was approved by the IMF Executive Board in July 2023. Fitch Ratings expected board approval of the recent SLA to be unproblematic. The successful programme review displays continued fiscal consolidation, energy price reforms amid public criticism, and moves towards a more market-determined exchange rate regime.
Several of Pakistan’s policy commitments under the SBA had been frontloaded, but the country’s caretaker set-up, which took office in August, has also taken some bold measures, including sharp hikes to natural gas and electricity rates followed by an aggressive crackdown on the black market, helping to bring the gap down between the parallel (kerb) and interbank exchange rates and bringing more FX into the banking system. In June, the previous government amended its proposed FY24 budget to introduce new revenue measures and cut spending, following additional tax measures and subsidy reforms in February.
Policy Implementation Risks: Parties across the political gamut in Pakistan have an extensive record of failing to implement or reverse reforms (including tax reforms) agreed with the IMF. We see a risk that the current consensus within the country on the measures required to ensure continued funding could dissipate quickly once economic and external conditions improve; however, Pakistan now has fewer financing options as compared to the past. Any follow-up IMF programme would obviously need the country to come up with sweeping structural reforms in opposition to entrenched vested interests.
Challenging Politics: We expect general elections to be held in February (as scheduled), and to produce a coalition government along the lines of Shebhaz Sharif’s government. Former prime minister Imran Khan’s Pakistan Tehreek-e-Insaf party likely remains popular, but its electoral prospects may be limited by Mr Khan’s imprisonment and the exit of senior leaders. Space for political expression has telescoped since widespread protests in May 2023. Nevertheless, further delays to the polls or renewed political instability could not be excluded and would endanger IMF negotiations and external funding.
Funding Trickling In: The IMF disbursed USD1.2 billion in July, and USD700 million would follow after approval of the recent SLA (expected in January), leaving USD1.1 billion to be disbursed after a review scheduled in March 2024. A few months before, Saudi Arabia provided USD2 billion in new deposits, coupled with USD1 billion funding from UAE. The government also received over USD500 million in project and commodity financing in the first quarter of the fiscal year ending June 2024 (FY24). A further USD1.1 billion in programme loans and over USD500 million in project loans appear likely in the remainder of 2023.
Overall Funding Targets Ambitious: The authorities expect total gross new external financing of USD18 billion in the next fiscal year, against nearly USD9 billion in government debt maturities. The maturing debt includes a USD1 billion bond due in April and USD3.8 billion to multilateral creditors but excludes routine rollovers of bilateral deposits. At the end of September, maturities in the remaining three-quarters of FY24 were just over USD7 billion. The government funding target comprises USD1.5 billion in Eurobond/sukuk issuance and USD4.5 billion in commercial bank borrowing, which would likely prove challenging.
Narrower External Deficit: We predict a current account deficit (CAD) of about USD2 billion (below 1% of GDP) in FY24, against FY23. Contractionary fiscal policies, lower commodity rates, and limited FX availability have driven the sharp narrowing of Pakistan’s Current Account Deficit (CAD) from over USD17 billion in FY22. Tight financing conditions, rupee devaluation and weak domestic demand would likely continue to constrain the CAD. The authorities intend for imports to be financed through banks, limiting the drain on official reserves, but banks have resorted to ad hoc, informal measures to prioritize access to FX by clients.
Recovered Reserves Still Low: Pakistan’s FX reserves have recovered on inflows of new funding and limited CADs, and we expect further inflows. Official gross reserves, including gold, were USD12.7 billion in October 2023 (about three months of imports), which went up from about USD8 billion at the start of 2023; however, well below the peak of USD23 billion at end-2021. The country’s central bank’s net liquid FX reserves have been hovering at just over USD7 billion since October 2023 (about two months of imports), from a low of about USD3 billion in January. A contraction in imports helped reserve coverage ratios.
Fiscal Deficits Remain Wide: We expect the consolidated general government (GG) fiscal deficit to narrow to 6.8% of GDP in FY24, from an approximate 7.8% in FY23, driven by an improvement in the primary balance to a surplus of 0.3% of GDP, from a primary deficit of 0.8% of GDP in FY23. The fiscal balance benefits from inflation, new revenue measures, and discipline on tax exemptions, subsidies, and other spending, including at the provincial level. However, further fiscal consolidation would be increasingly challenging.
High, Stable Debt Level: GG debt/GDP was about 75% of GDP in FY23, broadly in line with the median for ‘B’, ‘C’, and ‘D’ rating category sovereigns. Pakistan’s debt dynamics are stable owing to high nominal growth over the medium term, with high inflation offsetting the pressure from high domestic interest costs. Nevertheless, debt/revenue (over 650%) and interest/revenue (about 60%) are far worse than that of peers, largely due to very low revenue/GDP.
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, as is the case for all sovereigns. 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 22nd percentile.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Public Finances: The increasing likelihood of default, for instance, 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: Greater certainty on the continued availability of funding over the medium term, for example, in the context of a longer-term IMF programme.
External Finances: Rebuilding of foreign-currency reserves and further significant easing of external financing risks.
ENDORSEMENT POLICY
Fitch’s international credit ratings produced outside the EU or the United Kingdom, as the case may be, are endorsed for usage by regulated entities within the EU or the UK, respectively, for regulatory purposes, pursuant to the terms of the EU CRA Regulation or the UK Credit Rating Agencies (Amendment etc.) (EU Exit) Regulations 2019, as the case may be. Fitch’s approach to endorsement in the EU and the UK can be found on Fitch’s Regulatory Affairs page on Fitch’s website. The endorsement status of international credit ratings is provided within the entity summary page for each rated entity and in the transaction detail pages for structured finance transactions on the Fitch website. These disclosures are updated on a daily basis.
