ISLAMABAD: Fitch Ratings has affirmed Pakistan's long-term foreign-currency Issuer Default Rating (IDR) at "B-" with a stable outlook.
The rating agency in its latest update stated that Pakistan's "B-" rating reflects weak public finances, including large fiscal deficits and a high government debt/GDP ratio, a challenging external position characterized by large external debt repayments against low foreign-exchange reserves and low governance indicator scores.
The coronavirus pandemic has exacerbated these challenges by depressing economic growth and pressuring the public finances.
The external finances appear resilient to the shock due to the authorities' policy actions and continuing multilateral and bilateral financial support.
It further stated that policy actions by the authorities over the past couple of years eased external vulnerabilities prior to the coronavirus shock.
These included tighter monetary policy settings and the move to a more market-determined exchange rate regime, which contributed to a sharp narrowing of the current account deficit and a modest rebuilding of foreign-exchange reserves.
Greater exchange rate flexibility has continued during the pandemic and has been an important shock absorber.
Liquid gross foreign-exchange reserves rose to about $12.5 billion by end-July from $7.7 billion a year prior.
A sharp reversal in March of record non-resident inflows to local-currency government notes (reaching a stock of $3.2 billion in February) generated exchange rate volatility and a modest decline in foreign-exchange reserves.
Foreign holdings have stabilised since then, and reserves have been restored through multilateral and bilateral disbursements.
The central bank's net forward position has increased somewhat in the past months and net reserves remain negative, even though they have narrowed.
Fitch forecasts a further rise in liquid gross reserves to about $16 billion by end of fiscal year ending June 2021.
Pakistan's current account deficit narrowed to 1.1 percent of the GDP in fiscal year 2020, from a peak of 6.1 percent in fiscal year 2018, due mainly to import compression and lower oil prices.
Fitch forecasts a slight widening of the current account deficit to 1.7 percent in fiscal year 2021 due to a modest recovery in imports and declining remittances.
Remittances raised unexpectedly by 7.3 percent in 4th quarter of fiscal year 2020, but Fitch views this as temporary and expect a decline of about 10 percent in fiscal year 2021 due to the impact of the global economic shock on Pakistan's overseas workers.
It further stated that external financing requirements have declined, in line with the narrowing of the current account deficit.
However, the government's external debt repayments remain high at about $10.3 billion (about 80 percent of current gross liquid reserves) in fiscal year 2021 and $8.9 billion in fiscal year 2022.
The $3 billion in deposits at the central bank from Saudi Arabia were slated to be rolled over through 2022, but the Saudi authorities requested repayment on $1 billion of the deposits in July.
"In our baseline scenario, we assume the additional $2 billion will be rolled over when the respective tranches mature in December and January, but this is subject to some risk," Fitch added.
Pakistan has received approval for its participation in the G-20's Debt Service Suspension Initiative (DSSI), which will lower fiscal year 2021 debt repayments to bilateral creditors by roughly $2 billion.
The relief provided by bilateral creditors does not constitute a default under Fitch's definitions, and understand that the authorities have ruled out any request for participation by private creditors.
Access to external financing appears sufficient in the near-term to close any financing gap, underpinned by support from multilateral and bilateral creditors.
In April, the IMF board approved $1.4 billion in financing through its Rapid Financing Instrument.
The 39-month, $6 billion IMF programme, which began in July 2019, remains in place.
"We expect the second review to be completed in the coming months, although it has been delayed since March, due mainly to the IMF's willingness to facilitate the authorities' policy focus on the coronavirus response. We understand that both the IMF and government of Pakistan remain committed to the programme, which has facilitated significant financing from a range of multilateral institutions", it added.
Official bilateral and commercial bank borrowing from China has also been a key source of financing. The authorities have also indicated they plan to return to the international bond market later this calendar year.
Public finances are a rating weakness.
Fiscal consolidation efforts were affected by the coronavirus shock, but the general government fiscal deficit still declined to 8.1 percent of GDP in fiscal year 2020 from 9.1 percent in fiscal year 2019.
The shock weighed on revenue in 4th quarter of 2020, but it still increased 28 percent for the full year due in large part to base effects from low revenue collection during fiscal year 2019 and the authorities' earlier efforts to improve revenue collection.
The government passed a Rs1.2 trillion (2.9 percent of GDP) coronavirus support package in March to lift health spending and provide assistance to low-income households, although delayed disbursements limited the impact on the fiscal year 2020 deficit.
Limited headroom due to a large fiscal deficit, low revenue and high debt is likely to constrain further fiscal stimulus beyond the March package.
"We forecast the fiscal deficit to remain roughly stable at 8.2 percent in fiscal year 2021, due to the lingering impacts of the coronavirus shock. Under the recently passed fiscal year 2021 budget, the government targets a deficit of 7 percent, but, in Fitch's view, this target relies on optimistic revenue growth assumptions from ongoing administrative initiatives, as the budget does not contain new revenue raising measures", the rating agency added.
Fitch forecasts that Pakistan's debt/GDP ratio will rise to about 90 percent at FYE21, from 87.2 percent at FYE20, well above the 'B' median of 50.8 percent, increasing debt sustainability concerns.
The deterioration in the debt/GDP ratio is much more significant than Fitch expectation of an 80 percent level by FYE20 at its last review in January, due to the coronavirus shock, as well as further currency depreciation.
Under Fitch's baseline the debt ratio will begin a gradual decline in fiscal year 2022, to about 85 percent of GDP by FYE25, as the fiscal deficit narrows and GDP growth picks up.
Mitigating the risk around a high debt ratio is that roughly two-thirds of the debt stock is in local currency, compared with a 'B' median of about a third.
The government is also seeking to extend maturities to limit rollover risks by taking advantage of the apparent appetite from the domestic banking sector for longer-dated issues.
"We forecast GDP growth to rebound to 1.2 percent in fiscal year 2021, following a contraction of 0.4 percent in fiscal year 2020 resulting from the pandemic and the authorities' macro adjustment policies", it added.
Risks to the forecasts are skewed to the downside given uncertainty around the coronavirus.
Recent data show the spread of the virus to be declining, and the government appears keen to avoid re-imposition of widespread lockdown measures, opting instead for a 'smart lockdown' strategy of targeting coronavirus hotspots.
Recent locust infestations pose another downside risk to agriculture, and to the broader growth and the inflation outlook.
The monetary policy stance has been loosened to support the economy during the coronavirus shock.
The central bank cut the policy rate by a cumulative 625bp to 7 percent between March and June.
As a result, the real interest rate has turned negative, although Fitch forecasts that inflation will remain on a downward trajectory, averaging 7.8 percent during fiscal year 2021 from 10.7 percent in fiscal year 2020, supported by diminishing pass through from last year's substantial rupee depreciation.
The coronavirus poses a potential setback to the government's reform agenda, with policy focused on the pandemic response, and possibly affects the ability to advance politically challenging reforms.
Nevertheless, the government has undertaken some reforms in the past months, although further steps to address circular debt in the power sector - a key element of the IMF programme - have been delayed.
Pakistan's rating is constrained by structural weaknesses, reflected in weak development and governance indicators.
Per capita GDP of $1,264 is below the $2,867 median of its 'B' rated peers. Governance quality is also low in Pakistan with a World Bank Governance Indicator (WBGI) score in the 22nd percentile compared with a 'B' median in the 38th percentile.
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 WBGIs have in Fitch proprietary Sovereign Rating Model.
Pakistan has a low WBGI ranking at 22.5, reflecting the absence of a recent record of peaceful political transitions, relatively weak rights for participation in the political process, weak institutional capacity, uneven application of the rule of law and a high level of corruption.
Fitch's proprietary Sovereign Rating Model (SRM) assigns Pakistan a score equivalent to a rating of 'CCC+' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its Qualitative Overlay (QO), relative to rated peers, as follows: - Structural: +1 notch to adjust for the negative effect on the SRM of Pakistan's take-up of the DSSI, which prompted a reset of the "years since default or restructuring event" variable (which can pertain both to official and commercial debt). In this case, Fitch judged that the deterioration in the model as a result of the reset does not signal a weakening of the sovereign's capacity and willingness to meet its obligations to private-sector creditors.
Pakistan has an ESG Relevance Score of 5 for Political Stability and Rights, as WBGIs have the highest weight in Fitch's SRM and are highly relevant to the rating and a key rating driver with a high weight.
Domestic security risks and geopolitical tensions with neighbours also pose a risk to political stability.
Pakistan has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption, as WBGIs have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Pakistan has an ESG Relevance Score of 4 for Human Rights and Political Freedoms, as strong social stability and voice and accountability are reflected in the WBGIs that have the highest weight in the SRM.
They are relevant to the rating and a rating driver.
Pakistan has an ESG Relevance Score of 4 for Creditor Rights, as willingness to service and repay debt is relevant to the rating and is a rating driver, as for all sovereigns.
Copyright Business Recorder, 2020
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