Red flags: Ratings nudge down

It has been rightly said that the smooth functioning of any countrys economic system is contingent upon two key drives: macro-economic stability and institutional efficiency. With fiscal environment predicting doom and gloom in Pakistan, downgrade of Pakistans foreign and local currency bond rating by Moodys Investors Service last week did not come as a surprise. Taking a cue from a slew of ailing indicators, such as a wide trade deficit, feeble capital inflows, and interminable political turmoil, the rating agency has hauled down Pakistans foreign and local currency bond ratings by one notch to Caa1 from B3, with a negative outlook. The obligations rated Caa1 are considered as speculative of poor standing and subjected to very high credit risk. The key drivers responsible for setting the stage for the ratings cut cited by the rating agency are appalling balance of payment position, sizeable debt repayments to IMF, lower foreign exchange reserves and lack of harmony between political leaders and other major institutions. With local commercial banks holding a sizable exposure in the countrys sovereign instruments, the domestic banking industry became the first to feel the domino effect of the rating cut as the rating agency has also downgraded the ratings of the five largest domestic banks: Allied Bank, Habib Bank, MCB Bank, National Bank of Pakistan and United Bank, on Tuesday, following the action on sovereign instruments. The renowned credit rating agency has downgraded the local currency deposit rating of five banks by one notch to B3 from B2, along with a negative outlook. The rating cut was accompanied by lowering of their stand alone credit assessments to Caa1 from B3. Besides, the foreign-currency deposit rating of the five banks fell by two notches to Caa2 from B3. The domestic industrys exposure to sovereign investments can be gauged from the latest statistics revealed by SBP, suggesting that scheduled banks accounted for nearly 70 percent of the total outstanding sovereign instruments, including Treasury Bills, Pakistan Investment Bonds and Ijara Sukuk as of May 31, 2012. "The direct exposures of rated Pakistani banks to government bonds ranged between 252 percent to 430 percent of Tier1 capital as on December 2011 are making the banks capital bases vulnerable to sovereign credit developments", cited a press release issued by Moodys on Tuesday. The rating agency also slated the domestic banking industrys large exposure to Public Sector Entities indicate that the exposure of the five rated banks to PSE ranged between 63 percent to 139 percent of their Tier1 capital as of December, 2011. The tumultuous developments surrounding sovereign bonds bode ill for rupee stability and bonds. However, the policy makers are taking solace from two positive developments, stemming from improvement in Pakistan-US ties and lower international oil prices in the recent past, which would yield favourable effect on the countrys fiscal system.