Success can breed complacency

Fitch Ratings has affirmed Pakistan's Long-Term Foreign and Local-Currency Issuer Default Ratings (IDRs) at 'B' with stable outlooks. This is undoubtedly good news. Fitch Ratings has recognised that country's foreign exchange reserves have strengthened, fiscal deficit reduced and significant progress has been made on structural reforms. It has also been acknowledged that Pakistan's economic outlook has brightened and looks promising this year on the back of agricultural recovery and an influx of investments under the CPEC. There will also be a strong domestic demand with greater private consumption and a faster credit growth. Fitch expects the inflation rate to increase to 4.5 percent in 2016-17 and 4.8 percent in FY18 as commodity prices recover slowly. Pakistan's public debt/GDP ratio of 64.8 percent at the end of June, 2016 was higher than the "B" median of 56.7 percent but this ratio was likely to gradually fall in the medium-term if the country could sustain its progress with fiscal consolidation. Budget deficit was projected to narrow gradually if the economy performs in line with the baseline scenario and the government remains committed to the policy plans set out during the recent IMF programme. However, gross external financing needs could increase the country's vulnerability to shifts in investor sentiment. Fitch also expects the current account deficit to widen as energy prices start to recover and capital imports increase with higher infrastructure investment. Nonetheless, Fitch does not expect Pakistan to face external liquidity difficulties. Finance Minister Ishaq Dar has appreciated Fitch's latest credit rating, saying that it is an acknowledgement of government's economic policies.
The affirmation of Pakistan's "B" rating with a "Stable" outlook by a famous rating agency and some complimentary remarks about the direction of the economy constitute a favourable development. Since such observations are generally taken seriously by both local and foreign investors, the chances of attracting a higher level of investment increase with a better credit rating of the country and vice versa. As the saving rate of Pakistan's economy is dismally low to finance its investment effort, the importance of upgrading the credit rating is thus obvious. Not only will higher foreign investment spur economic growth, reduce unemployment and poverty, it will also play a role in improving technology and skill levels in production process. Better credit ratings could also give the needed confidence to policymakers. However, it needs to be noted that the affirmation of Pakistan's rating seems to be based on some optimistic assumptions and outdated developments. Fitch is right about a moderate rise in the GDP growth rate and containment in prices but most of the other indicators of economy are in a poor shape. On the external front, exports and home remittances are declining while the C/A deficit has risen sharply. Country's foreign exchange reserves have also started falling in recent weeks while foreign investment continues to be at a dismally low level. External debt servicing costs are likely to increase in the medium-term, with dollar 2.75 billion of international bonds maturing between 2016-17 and 2019-20 and repayment of dollar 6.4 billion IMF facility and dollar 11.7 billion of rescheduled Paris Club debt in 2017-18 and 2016-17 respectively, albeit over an extended timeframe. The external sector may come under increased pressure due to a further rise in the prices of oil in the international market. On the domestic front, FBR is finding it difficult to meet the current year's target of revenue collection and, as such, the government could face the pressure of a higher budget deficit which is already forcing it to borrow increasingly from the banking system and violate the terms of the FRDL Act of 2005. Twin deficits of the country are increasing and, contrary to the perception of Fitch, the government is gradually tilting away from the basic understandings with the IMF. It may further violate the fiscal discipline as the election time comes nearer. It may also be noted that rating agencies themselves have lately come under strong criticism at the international level due to their misreading of the situation in certain cases. As such, the veracity of their rankings cannot be absolutely guaranteed. Overall, however, we are pleased with the Fitch's affirmation of the country's rating but would advise the government not to be carried away by its complimentary remarks. It must try to concentrate on the real task of reforming the economy without any further loss of time.