Hong Kong July 10 2023: Fitch Ratings has upgraded Pakistan's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'CCC' from 'CCC-'. Fitch typically does not assign Outlooks to sovereigns with a rating of 'CCC+' or below.
KEY RATING DRIVERS
Easing External Financing Risks: The upgrade reflects Pakistan's improved external liquidity and funding conditions following its Staff-Level Agreement (SLA) with the IMF on a nine-month Stand-by Arrangement (SBA) in June. We expect the SLA to be approved by the IMF board in July, catalysing other funding and anchoring policies around parliamentary elections due by October. Nevertheless, programme implementation and external funding risks remain due to a volatile political climate and large external financing requirement.
IMF-Driven Reforms: Pakistan has recently taken measures to address shortfalls in government revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate, including import financing restrictions. These issues held up the last three reviews of Pakistan's previous IMF programme, before its expiry in June.
Most recently, the government amended its proposed budget for the fiscal year ending June 2024 (FY24) to introduce new revenue measures and cut spending, following additional tax measures and subsidy reforms in February. The authorities appeared to abandon exchange-rate management in January 2023, although guidelines on prioritising imports were only removed in June.
Implementation Risks: Pakistan has an extensive record of going off-track on its commitments to the IMF. We understand the government has already made all the required policy actions under the SBA. Nevertheless, there is still scope for delays and challenges to implementation as well as new policy missteps ahead of the October elections and uncertainty over the post-election commitment to the programme.
New Funding Unlocked: IMF board approval of the SBA will unlock an immediate disbursement of USD1.2 billion, with the remaining USD1.8 billion scheduled after reviews in November and February 2024. Saudi Arabia and the United Arab Emirates have committed another USD3 billion in deposits, and the authorities expect USD3-5 billion in other new multilateral funding after the IMF agreement. The SBA should also facilitate disbursement of some of the USD10 billion in aid pledges made at the January 2023 flood relief conference, mostly in the form of project loans (USD2 billion in the budget).
Overall Funding Targets Ambitious: The authorities expect USD25 billion in gross new external financing in FY24, against USD15 billion in public debt maturities, including USD1 billion in bonds and USD3.6 billion to multilateral creditors. The government funding target includes USD1.5 billion in market issuance and USD4.5 billion in commercial bank borrowing, both of which could prove challenging, although some of the loans not rolled over in FY23 could now return. USD9 billion in maturing deposits from China, Saudi Arabia and the UAE will likely be rolled over, as in FY23.
Narrower External Deficit: Pakistan's current account deficit (CAD) has narrowed sharply, driven by earlier restrictions on imports and FX availability, tighter fiscal and economic policies, measures to limit energy consumption and lower commodity prices. Pakistan posted current account surpluses in March-May 2023, and we forecast a CAD of about USD4 billion (1% of GDP) in FY24, after USD3 billion in FY23 and over USD17 billion in FY22. Our forecast CAD is lower than the USD6 billion in the budget, on the assumption that not all of the planned new funding will materialise, constraining imports.
External Deficit Risks: The CAD could widen more than we expect, given continued reports of import backlogs, the dependence of the manufacturing sector on foreign inputs, and reconstruction needs after last year's floods. Nevertheless, currency depreciation could limit the rise, as the authorities intend for imports to be financed through banks, without recourse to official reserves. Remittance inflows could also recover after partly switching to unofficial channels to benefit from more favourable parallel market exchange rates.
The 'CCC' Long-Term Foreign-Currency IDR also reflects the following factors:
Reserves Still Low: Liquid net FX reserves of the State Bank of Pakistan have hovered around USD4 billion since February 2023, or less than a month of imports, down from a peak of more than USD20 billion at end-August 2021. The collapse in reserves reflected large CADs, external debt servicing and earlier FX intervention by the central bank. We expect a modest recovery for the rest of FY24 on new external financing flows, although these flows will also lead to a renewed widening of the CAD.
Volatile Politics: Protests by supporters of former prime minister Imran Khan and his PTI party sharply intensified in May as Mr Khan was briefly arrested on corruption charges, culminating in attacks on army facilities. In the ensuing crackdown, a large number of PTI members were arrested, with several high-ranking PTI politicians quitting politics. Nevertheless, the enduring popularity of Mr Khan and PTI create policy uncertainty around elections.
Fiscal Deficits Remain Wide: We expect the consolidated general government (GG) fiscal deficit to widen to 7.6% of GDP in FY24, from an estimated 7.0% in FY23, driven by higher interest costs on domestic debt, which accounts for the difference between our forecast and a GG deficit of 7.1% of GDP in the revised FY24 budget statement (with a lower figure of 6.5% in the medium-term fiscal framework). Fiscal consolidation will drive a slight improvement in our forecast GG primary deficit to 0.1% of GDP in FY24, from 0.5% of GDP in FY23.
High, Stable Debt Level: The GG debt/GDP of 74% at FYE23 is in line with the median for 'B', 'C' and 'D' rating category sovereigns and debt dynamics are broadly stable owing to high nominal growth over the medium term. Nevertheless, debt/revenue (over 600%) and interest/revenue (nearly 60%) are far worse than that of peers.
Government Considering Bilateral Maturity Extension: The finance minister recently said that Pakistan would seek maturity extensions on loans by non-Paris club bilateral creditors, while reaffirming the government's commitment to timely debt service. We understand that such maturity extensions would mostly relate to loans and deposits by China, Saudi Arabia and the UAE, which are already regularly rolled over.
In 2022, the prime minister and former finance minister raised the possibility of seeking debt relief from non-commercial creditors, including the Paris Club, but the authorities now appear to have moved away from this. Should Paris Club debt treatment be sought, Paris Club creditors are likely to require comparable treatment for private external creditors in any restructuring.
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 WBGI ranking at the lower 22nd percentile.
