New York July 19 2022: Ratings agency Fitch on Tuesday revised its outlook on Pakistan to negative from stable, citing deterioration in country’s external liquidity position and financing conditions since early 2022.
Fitch affirmed Pakistan’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at ‘B-‘.
Key Rating Drivers
Risks to Adjustment, Financing: The Revision of the Outlook to Negative reflects significant deterioration in Pakistan’s external liquidity position and financing conditions since early 2022. We assume IMF board approval of Pakistan’s new staff-level agreement with the IMF, but see considerable risks to its implementation and to continued access to financing after the programme’s expiry in June 2023 in a tough economic and political climate.
Political Risks: Renewed political volatility cannot be excluded and could undermine the authorities’ fiscal and external adjustment, as happened in early 2022 and 2018, particularly in the current environment of slowing growth and high inflation.
Former Prime Minister Imran Khan, who was ousted in a no-confidence vote on 10 April, has called on the government to hold early elections and has been organising large-scale protests in cities around the country. The new government is supported by a disparate coalition of parties with only a slim majority in parliament. Regular elections are due in October 2023, creating the risk of policy slippage after the conclusion of the IMF programme.
Reserves under Pressure: Limited external funding and large current account deficits (CADs) have drained foreign exchange (FX) reserves, as the State Bank of Pakistan (SBP) has used reserves to slow currency depreciation. Liquid net FX reserves at the SBP declined to about USD10 billion or just over one month of current external payments by June 2022, down from about USD16 billion a year earlier.
External Deficits: We estimate the CAD reached USD17 billion (4.6% of GDP) in fiscal year ended June 2022 (FY22), driven by soaring global oil prices and a rise in non-oil imports boosted by strong private consumption. Fiscal tightening, higher interest rates, measures to limit energy consumption and imports underpin our forecast of a narrowing CAD to USD10 billion in FY23.
External Deficits: We estimate the CAD reached USD17 billion (4.6% of GDP) in fiscal year ended June 2022 (FY22), driven by soaring global oil prices and a rise in non-oil imports boosted by strong private consumption. Fiscal tightening, higher interest rates, measures to limit energy consumption and imports underpin our forecast of a narrowing CAD to USD10 billion (2.6% of GDP) in FY23.
Large Funding Needs: Public debt maturities in FY23 are about USD21 billion. Maturities of about USD9 billion are to bilateral creditors (chiefly Saudi Arabia and China), which should be fairly easy to roll over with an IMF programme in place. Much of the USD5 billion in debt to commercial banks is also to China. Staff-level agreement will potentially unlock USD4 billion in IMF disbursements to Pakistan in FY23, assuming board approval of a USD1 billion augmentation and extension to June 2023.
Policy Getting Back on Track: Pakistan’s ‘B-‘ rating reflects recurring external vulnerability, a narrow fiscal revenue base and low governance indicator scores compared with the ‘B’ median. External funding conditions and liquidity will likely improve with the new staff-level agreement. Nevertheless, slippage against programme conditions is a risk and could quickly lead to renewed strains, while diminished FX reserves and high funding needs now leave less room for error. Pakistan’s access to market finance could remain constrained.
Fiscal Worsening then Consolidation: We estimate that the fiscal deficit widened to 7.5% of GDP (nearly PKR5 trillion) in FY22, from 6.1% in FY21. Tax reductions and subsidies on fuel and electricity account for most of the fiscal deterioration; these were introduced by the previous government in February and lasted until June.
We expect a narrowing of the deficit to 5.6% of GDP (about PKR4.6 trillion or USD22 billion) in FY23, driven by spending restraint as well as by expanded taxation, including higher corporate and personal income taxes and increases in the petroleum levy. Our forecast of the fiscal deficit is about 1% of GDP wider than the authorities’ target.
Debt Expected to Decline: We estimate Pakistan’s debt/GDP at 73% as at FYE22, broadly in line with the current ‘B’ median, following an earlier GDP rebasing in FY21, which lowered the debt ratio by 12pp. We expect debt/GDP to decline to 66% in FY23 and remain on a downward trend, helped by high inflation and a modest primary deficit, which we forecast at 0.9% of GDP in FY23, down from 2.8% of GDP in FY22.
Other Debt Metrics Mixed: A low FX exposure at just over 30% of on a downward trend, helped by high inflation and a modest primary deficit, which we forecast at 0.9% of GDP in FY23, down from 2.8% of GDP in FY22.
Other Debt Metrics Mixed: A low FX exposure at just over 30% of total debt has limited the negative impact of currency depreciation on debt dynamics. Nevertheless, debt/revenue (at over 600% in FY22) and interest/revenue (at about 40%) are significantly worse than the ‘B’ median. This largely reflects low general government revenue of 12% of GDP in FY22.
High Inflation, Monetary Tightening: Consumer price inflation averaged 12.2% in FY22 but accelerated to 21.3% yoy (6.3% mom) in June on hikes to petrol and electricity prices. The SBP forecast inflation of 18%-20% in FY23, as it raised its policy rate by 125bp to 15% at its most recent action on 7 July. SBP’s latest action took cumulative rate hikes to 800bp in this latest tightening cycle.
Our forecast of average inflation of 19% in FY23 and 8% in FY24 largely reflects base effects, but recent and planned future energy price hikes will all fuel broad-based inflation and mean inflation is skewed to the upside.
Overheated Economy; FallingGrowth: Preliminary estimates show real GDP growth of 6% for FY22, up from 5.7% in FY21, mostly driven by private consumption, as in FY21, while net exports continued to weigh on growth. In our view, this largely reflected a loosening of fiscal policy in FY22, as well as a fairly loose monetary policy despite significant tightening throughout the year (ex-post real policy rates on average negative in FY22).
The SBP estimates that the economy was operating above potential in FY22, and we forecast slower growth of 3.5% in FY23 amid fiscal and monetary tightening, high imported inflation, and a weaker external demand outlook, all of which will also hit household and business confidence.
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 low WBGI ranking at the lower 22nd percentile.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade are
External Finances: Lack of improvement in external liquidity and funding conditions
