Thursday Jun 02, 2022

Moody’s Investors Service downgrades Pakistan’s outlook to negative

— Reuters/File
— Reuters/File

  • "Agreement with IMF could take longer than expected," Moody's warn.
  • Decision to change outlook is driven by Pakistan’s heightened external vulnerability risk.
  • Moody's expects Pakistan's current account to remain under significant pressure.

SINGAPORE: Moody’s Investors Service Thursday downgraded the outlook on Pakistan’s rating to negative from stable and affirmed the ‘B3’ local and foreign currency long-term issuer and senior unsecured debt ratings.

The decision to change the outlook to negative is driven by Pakistan’s heightened external vulnerability risk and uncertainty around the sovereign's ability to secure additional external financing to meet its needs.

“Moody's assesses that Pakistan's external vulnerability risk has been amplified by rising inflation, which puts downward pressure on the current account, the currency and — already thin — foreign exchange reserves, especially in the context of heightened political and social risk,” a statement issued by the credit rating agency read.

It further added that Pakistan's weak institutions and governance strength add uncertainty around the future direction of macroeconomic policy, including whether the country will complete the current International Monetary Fund (IMF) Extended Fund Facility (EFF) programme and maintain a credible policy path that supports further financing.

Read more: Economic inconsistency and Pakistan's future

However, it stated that the decision to affirm the B3 rating reflects Moody's assumption that, notwithstanding the downside risks mentioned above, Pakistan will conclude the seventh review under the IMF EFF programme by the second half of this calendar year, and will maintain its engagement with the IMF, leading to additional financing from other bilateral and multilateral partners.

In this case, Moody's assessed that Pakistan would be able to close its financing gap for the next couple of years.

— Bloomberg/Topline
— Bloomberg/Topline

“The B3 rating also incorporates Moody's assessment of the scale of Pakistan's economy and robust growth potential, which will provide the economy with some capacity to absorb shocks. These credit strengths are balanced against Pakistan's fragile external payments position, weak governance and very weak fiscal strength, including very weak debt affordability.

Moody’s maintained that the B3 rating affirmation also applies to the backed foreign currency senior unsecured ratings for The Third Pakistan International Sukuk Co Limited and The Pakistan Global Sukuk Programme Co Ltd. The associated payment obligations are, in Moody's view, direct obligations of the Government of Pakistan.

“Concurrent to today's action, Pakistan's local and foreign currency country ceilings have been lowered to B1 and B3, from Ba3 and B2,” the statement read.

Read more: Pakistan's IMF programme hinges on govt's ability to make fiscal adjustments

It identified the government's relatively large footprint in the economy, weak institutions, and relatively high political and external vulnerability risk as major drivers behind the two-notch gap between the local currency ceiling and sovereign rating

“The two-notch gap between the foreign currency ceiling and the local currency ceiling reflects incomplete capital account convertibility and relatively weak policy effectiveness, which points to material transfer and convertibility risks notwithstanding moderate external debt.”   

Pakistan's current account to remain under pressure

The rating agency expects Pakistan's current account to remain under significant pressure, on the back of elevated global commodity prices through 2022 and 2023.

It is mentioned that Pakistan's current account deficit has widened to a cumulative $13.8 billion since the start of the current fiscal year in July 2021 up until April 2022, compared to a deficit of $543 million in the same period a year earlier.

"In the absence of an equivalent inflow in the financial account, the rapid widening of the current account deficit has led to a large drawdown of the foreign exchange reserves," the statement read.

Read more: Inflation clocks in at 13.8% in May

Moody's projected that the current account deficit would clock in at 4.5-5% of GDP for fiscal 2022 (ending June 2022), slightly wider than the government's expectations.

It further added that as global commodity prices decline gradually in 2023 and as domestic demand moderates, Moody's expects the current account deficit to narrow to 3.5-4% of GDP.

It is worth mentioning that Moody's current account deficit forecasts are higher than previous (early February 2022) projections of 4% and 3% for fiscal 2022 and 2023.

The larger current account deficits underscore the need for Pakistan to secure additional external financing, especially given its very low foreign exchange reserves. Pakistan is in negotiations with the IMF on the seventh review of the EFF programme. 

Moody's expects Pakistan to successfully conclude the review by the second half of the year, with the associated IMF financing to be disbursed then. The conclusion of the seventh review, and further engagement with the IMF, will also help Pakistan secure financing from other bilateral and multilateral partners. 

Read more: 'Hard to imagine buying Russian oil', Miftah Ismail says in CNN interview

In this scenario, Moody's expects Pakistan to be able to fully meet its external obligations for the next couple of years.

"An agreement with IMF could take longer than expected, as the government may find it difficult to reduce fuel and power subsidies given rising inflation," it predicted, adding that recent moves by the government to raise fuel prices signal its commitment to addressing issues raised by the IMF.

Still, political and social challenges will "complicate the government's efforts to agree on and implement further reforms", such as revenue-raising reforms.

"While not Moody's baseline scenario, if Pakistan is unable to secure additional financing later this year, foreign exchange reserves will continue to be drawn down from already very low levels, increasing the risk of a balance of payments crisis," the statement read.

Political uncertainty in Pakistan 'remains high'

The credit rating agency assesses that political uncertainty in Pakistan "remains high", even after the new government has been installed. The new ruling coalition comprises multiple political parties with divergent interests, which is likely to make the enactment of any legislation difficult, including those related to reforms under the IMF EFF programme.

"The next elections are due by the middle of 2023. In Moody's view, political parties will find it difficult to continually enact significant revenue-raising measures in the run-up to the elections, especially in a high inflation environment," it warned, adding that rising interest rates are also likely to increasingly constrain the government's policy choices, especially since interest payments already absorb more than 40% of revenue.

It also mentioned that domestic political risk has also risen with a higher frequency of terrorist attacks over the last year. "More frequent terrorist attacks add to safety concerns, which may increase social risks, as well as constrain business conditions and limit investment."

Moody's assessed that there is a "material probability" of a recurrence in domestic political stress that will "impinge" on the effectiveness of policymaking and the government's ability to implement timely economic reforms aimed at achieving macroeconomic stability.