Hong Kong December 14 2023: Fitch sees high external funding risks amid high medium-term financing requirements, despite some stabilisation and Pakistan’s strong performance on its current Stand-by Arrangement (SBA) with the IMF.
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.
External Risks Easing; Still High: The ‘CCC’ rating reflects high external funding risks amid high medium-term financing requirements, despite some stabilisation and Pakistan’s strong performance on its current Stand-by Arrangement (SBA) with the IMF. We expect elections to take place as scheduled in February and a follow-up IMF programme 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 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 programme 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 programme would likely require Pakistan to undertake sweeping structural reforms in opposition to entrenched vested interests.
Challenging Politics: We expect 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 Mr 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 jeopardise IMF negotiations and external funding.
Funding Trickling In: The IMF disbursed USD1.2 billion in July, and USD700 million will follow after approval of the recent SLA, leaving USD1.1 billion to be disbursed after a review scheduled in March 2024. Saudi Arabia provided USD2 billion in new deposits, and the UAE provided USD1 billion. 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 FY24, 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 end-September, maturities in the remaining three quarters of FY24 were just over USD7 billion. The government funding target includes USD1.5 billion in Eurobond/sukuk issuance and USD4.5 billion in commercial bank borrowing, which will likely prove challenging.
Narrower External Deficit: We forecast a current account deficit (CAD) of about USD2 billion (below 1% 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 USD17 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 USD12.7 billion in October 2023 (about three months of imports), up from about USD8 billion at the start of 2023, but well below the peak of USD23 billion at end-2021. The 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 estimated 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 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% 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.
