S&P Global Ratings has affirmed its 'B-' long-term and 'B' short-term sovereign credit rating on Pakistan, while outlook for the long-term rating is stable.
The financial information agency also affirmed 'B-' long-term issue rating on Pakistan's senior unsecured debt and sukuk trust certificates.
“The stable outlook reflects our expectations that donor and partner financing will ensure that Pakistan is able to meet its external obligations over the next 12 months, and that external, fiscal, and economic metrics will not deteriorate materially beyond our current projections,” said S&P Global Ratings in its latest update.
“We may lower our ratings if Pakistan's fiscal, economic, or external indicators continue to deteriorate, such that the government's external debt repayments come under pressure. Indications of this would include GDP growth below our forecast, or external or fiscal imbalances higher than what we expect,” it said.
The agency said that it could raise its ratings on Pakistan if the economy materially outperforms expectations, strengthening the country's fiscal and external positions more quickly than forecast.
“The ratings on Pakistan reflect subdued expectations for the country's economic growth, heightened external indebtedness and liquidity needs, and an elevated general government fiscal deficit and debt stock. While Pakistan has secured financial aid from the IMF and numerous other international partners to address its immediate external financing needs, fiscal and external imbalances will remain elevated over the near to medium term,” said S&P.
The London-based company said that the economic slowdown results from a paucity of growth drivers. In particular, real investment contracted sharply by 8.9% in the fiscal year ended June 2019, the worst performance since fiscal 2011. It said that prospects for a rapid recovery in investment are limited owing to the fading impulse from China-Pakistan Economic Corridor (CPEC) related projects, along with cautious sentiment in the private sector.
“Nevertheless, the government has begun to implement more powerful economic reform measures, in line with its agreement to a $6 billion, 39-month extended funding facility with the IMF,” said the agency, which includes fiscal reforms aimed at increasing the government's revenue mobilisation, as well as the introduction of and commitment to a more flexible, market-determined exchange rate regime.
S&P Global said that ratings on Pakistan remain constrained by a narrow tax base and domestic and external security risks, which continue to be high. It said that although the country's security situation has gradually improved over the recent years, ongoing vulnerabilities weaken the government's effectiveness and weigh on the business climate.
The agency said that Pakistan's economy has begun a period of structural adjustment which entails slower real GDP growth as officials address significant external and fiscal imbalances.
“In view of the negative impulse stemming from the government's nascent fiscal reforms, as well as weak domestic and external demand conditions, we expect real GDP growth to fall to 2.4% this fiscal year--a 12-year low. Taken together with Pakistan's relatively fast population growth of approximately 2.0% per year, real per capita economic growth will fall to an anemic 0.4%. That will contribute to a decline in Pakistan's 10-year weighted average per capita growth to 1.8%, below the global average of 2.3% for economies at a similar level of income,” it said.
S&P Global said that the decline of Pakistani rupee by approximately 25% against the US dollar in fiscal 2019 has also contributed to a decline in the economy's nominal GDP per capita. “We forecast GDP per capita to fall to just above US$1,200 by the end of this fiscal year, versus US$1,565 in fiscal 2017-2018,” it said.
S&P Global Ratings said that despite economic reforms, including the introduction of enhanced flexibility for the Pakistani rupee, will help to stabilize and eventually support a recovery in economic activity, this effect is unlikely to sufficiently offset the loss in momentum in the economy during this period of acute fiscal and external stress.
Growth will also be constrained by domestic security challenges and extended hostility with neighbouring India and Afghanistan. These conditions, along with inadequate infrastructure, mainly in transportation and energy, are additional bottlenecks to foreign direct investments.
“The former Pakistan Muslim League government improved the security situation within the country, and we would expect the Pakistan Tehreek-e-Insaf (PTI) government to continue this positive momentum. However, tensions with neighboring India have flared on multiple occasions in 2019, and further incidents, especially in the vicinity of the line of control in Kashmir, cannot be ruled out,” it said.
S&P Global Ratings said that Pakistan is facing considerable external and fiscal pressure following a significant rise in both general government and external indebtedness in the fiscal year ended June 2019. These metrics have deteriorated owing largely to aggressive external fund raising and the rupee's rapid depreciation, because the central bank allowed the currency to weaken in line with fundamentals following a period of overvaluation.
In order to meet the economy's elevated external funding needs, the government has secured substantial foreign exchange support from a large contingent of multilateral and bilateral creditors. Creditors including the IMF, Saudi Arabia, UAE, Qatar, and China, among others, have committed to total support for Pakistan of approximately US$38 billion.
S&P Global Ratings believes that these funds will help to alleviate acute external stresses and to supplement the central bank's limited foreign exchange reserves.
“We believe the combined support from Pakistan's international partners will add to debt, but will also help to smooth pressing external financing needs. However, more will need to be done to stem Pakistan's vulnerability over the long term, especially on export promotion and energy security,” said S&P Global Ratings.
The agency said Pakistan’s current account deficit decreased to 4.8% of GDP in the fiscal year ended June 2019, from 6.3% the year before. The narrowing of the deficit was due largely to import compression amid weakening demand, especially following official administrative measures, along with the decreased purchasing power of the Pakistani rupee. S&P Global Ratings expect the current account deficit to continue to decline gradually over the next few years as the economy rebalances.
“Although we expect the current account deficit to decline somewhat over the next three years, Pakistan's external financing and indebtedness metrics exhibit significant stress. Its high degree of external stress is marked by a continued rise in the economy's gross external financing needs relative to its current account receipts and usable reserves; we forecast this ratio will climb to approximately 161% at the end of fiscal 2020, versus approximately 133% at the end of fiscal 2018.
“We deduct approximately US$8 billion from gross reserves owing to the central bank's net short position with the domestic commercial banking sector, resulting in usable reserves of just US$1.9 billion as of the end of fiscal 2019.”
The agency said that although they believe the State Bank of Pakistan (SBP) will gradually pare down its net short position over the coming years, usable reserves will remain modest in terms of import cover.
“Meanwhile, we project the country's narrow net external debt will rise to approximately 188% of current account receipts this fiscal year, from just 140% two years prior. Although external aid will help to meet immediate payment needs, indebtedness will also rise.”
S&P Global Ratings said that Pakistan's fiscal profile has deteriorated, as evident from a surge in the general government's budget deficit to an estimated 8.9% of GDP in fiscal 2019. The government is in the process of implementing difficult reform measures, which will aim to rein in its deficit largely through revenue generation. Change in net general government debt rose to 13.3% in fiscal 2019 versus 9.3% in the previous year, largely owing to the government's higher fiscal deficit, the depreciation of the Pakistani rupee, and borrowing from bilateral and multilateral partners.
“Under the auspices of the IMF EFF program, the government has elucidated its aim to consolidate its fiscal accounts, and we believe it can make material progress toward achieving lower annual fiscal deficits and a greater revenue share of GDP.”
S&P Global Ratings highlighted that Pakistan's ratio of tax revenue to GDP remains one of the lowest among sovereigns, and improvements in collection will be critical in determining the success of its fiscal reform program.
Constructive measures including the withdrawal of exemptions and preferential rates under the government's sales tax regime, a rationalization of income tax thresholds and rates, and the augmentation of Federal Excise Duties, among others, should help to solidify the government's revenue base beginning this fiscal year. A proposed strengthening of the Fiscal Responsibility and Debt Limitation Act should contain fiscal risks over the long term, said the agency.
Reforms in the energy sector also constitute an important pillar of the government's agenda, especially given the recent rise in circular debt (arrears) stemming from imbalances in the power sector. The total stock of circular debt stood at more than 4% of GDP as of March 2019, according to IMF estimates. This poses a contingent liability to the sovereign. The authorities' implementation of an automatic quarterly tariff adjustment scheme, along with further structural changes to the sector under its comprehensive strategy planned for introduction in September, should help to alleviate this risk.
“However, we also note the difficulty in growing revenue as a share of GDP during a period of muted economic growth; we therefore expect the government's revenue-to-GDP ratio to rise only gradually over the next three years. We forecast the average annual change in net general government debt at 6.9% of GDP through 2022, which is higher than our previous expectations. “Coupled with our lower expectations for real GDP growth, the forecast fiscal deficits will gradually raise net general government indebtedness close to 75% of GDP by the end of 2022,” it said.
Pakistan's unusually high interest expense relative to fiscal revenue is an additional constraint on our assessment of the government's debt burden. Interest expense consumes more than a third of government revenue, partly a function of its narrow tax base, it said.