Fitch Ratings has affirmed 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.

Fitch said that the ‘CCC’ rating reflects high external funding risks amid high medium-term financing requirements, despite some stabilization and Pakistan’s strong performance on its current Stand-by Arrangement (SBA) with the IMF.

Fitch said it expects elections to take place as scheduled in February and a follow-up IMF program to be negotiated quickly after the SBA finishes in March 2024, but there is 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 of the country’s nine-month SBA, which was approved by the IMF Executive Board in July 2023. We expect board approval of the recent SLA to be unproblematic. The successful program review reflects continued fiscal consolidation, energy price reforms in the face of a public backlash, and moves towards a more market-determined exchange rate regime.

Many of Pakistan’s policy commitments under the SBA had been frontloaded, but Pakistan’s caretaker government, which took office in August, has also taken new measures, including sharp hikes to natural gas and electricity prices and a crackdown on the black market, helping narrow the gap 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 spectrum in Pakistan have an extensive record of failing to implement or reversing reforms agreed with the IMF.

“We see a risk that the current consensus within Pakistan on the measures necessary to ensure continued funding could dissipate quickly once economic and external conditions improve, although Pakistan now has fewer financing options than in the past. Any follow-up IMF program would likely require Pakistan to undertake sweeping structural reforms in opposition to entrenched vested interests,” said the credit rating agency.

Challenging Politics

Fitch said it expects general elections to take place as scheduled in February, 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 Khan’s imprisonment and the departure of senior leaders. Space for political expression has shrunk since widespread protests in May 2023.

“Nevertheless, further delays to elections or renewed political volatility cannot be excluded and would jeopardize IMF negotiations and external funding,” it said.

Funding Trickling In

The IMF disbursed $1.2 billion in July, and $700 million will follow after approval of the recent SLA, leaving $1.1 billion to be disbursed after a review scheduled in March 2024. Saudi Arabia provided $2 billion in new deposits, and the UAE provided $1 billion. The government also received over $500 million in project and commodity financing in the first quarter of the fiscal year ending June 2024 (FY24). A further $1.1 billion in program loans and over $500 million in project loans appear likely in the remainder of 2023.

Overall Funding Targets Ambitious

The authorities expect total gross new external financing of $18 billion in FY24, against nearly $9 billion in government debt maturities. The maturing debt includes a $1 billion bond due in April and $3.8 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 $7 billion. The government funding target includes $1.5 billion in Eurobond/sukuk issuance and $4.5 billion in commercial bank borrowing, which will likely prove challenging.

Narrower External Deficit

Fitch forecasts a current account deficit (CAD) of about $2 billion (below 1 percent of GDP) in FY24, in line with FY23. Contractionary fiscal policies, lower commodity prices and limited FX availability have driven the sharp narrowing of Pakistan’s CAD from over $17 billion in FY22. Tight financing conditions, rupee depreciation and weak domestic demand will 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 prioritise access to FX by clients.

Reserves Have Recovered; Still Low

Pakistan’s FX reserves have recovered on inflows of new funding and limited CADs, and we expect further increases. Official gross reserves, including gold, were $12.7 billion in October 2023 (about three months of imports), up from about $8 billion at the start of 2023, but well below the peak of $23 billion at end-2021. The central bank’s net liquid FX reserves have been hovering at just over $7 billion since October 2023 (about two months of imports), from a low of about $3 billion in January. A contraction in imports helped reserve coverage ratios.

Fiscal Deficits Remain Wide

The rating agency expects the consolidated general government (GG) fiscal deficit to narrow to 6.8 percent of GDP in FY24, from an estimated 7.8 percent in FY23, driven by an improvement in the primary balance to a surplus of 0.3 percent of GDP, from a primary deficit of 0.8 percent of GDP in FY23. The fiscal balance is benefitting from inflation, new revenue measures, as well as discipline on tax exemptions, subsidies and other spending, including at the provincial level. However, further fiscal consolidation will be increasingly challenging.

High, Stable Debt Level

GG debt/GDP was about 75 percent 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 percent) and interest/revenue (about 60 percent) 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 Fitch’s proprietary Sovereign Rating Model (SRM). Pakistan has a WBGI ranking at the 22nd percentile.

Source: Pro Pakistani