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ISLAMABAD: S&P Global Ratings (previously Standard and Poor’s) revised the outlook on Pakistan’s long-term ratings to negative from stable on weakening external position due to higher commodity prices, rupee depreciation, and tighter global financial conditions. The ratings agency also affirmed its “B-” long-term and “B” short-term sovereign credit ratings on Pakistan, as well as “B-” long-term issue rating on Pakistan’s senior unsecured notes and the sukuk trust certificates.

The S&P Ratings noted that the negative outlook reflects growing risks to Pakistan’s external liquidity position over the next 12 months amid an increasingly difficult economic landscape.

“We may lower our ratings if Pakistan’s external indicators continue to deteriorate to the extent that the government’s commitments appear to be unsustainable in the long term. Downward pressure on the ratings would emerge if financial support from bilateral and multilateral partners quickly erodes, or usable foreign exchange reserves fall further to levels indicating distress in servicing Pakistan’s external debt obligations”, said the S&P Global Ratings.

The ratings agency further stated that it may revise the outlook to stable if Pakistan’s external position stabilizes and improves from current levels. Evidence of improvement could include a sustained rise in usable foreign exchange reserves.

The agency stated that the outlook was revised to negative to reflect Pakistan’s weakening external metrics against a backdrop of higher commodity prices, tighter global financial conditions, and a weakening rupee. The Pakistan government has considerable external indebtedness and liquidity needs, and an elevated general government fiscal deficit and debt stock. Although the impact of these more difficult macroeconomic conditions has been partially mitigated by various reform initiatives undertaken by the government over the past few years, the risk of continued deterioration in key metrics, including external liquidity, is rising.

Moody's downgrades Pakistan's outlook to negative from stable

The report noted that Pakistan’s economy continues to rebound from a pandemic-driven slowdown. Domestic demand continues to recover but is now facing a new challenge in the form of rising prices, particularly for staple goods. Prevailing price dynamics, including costlier edible oils, fuel, electricity, and grains, are likely to hurt the pace of private consumption growth in the current fiscal year ending June 2023.

Pakistan has made progress toward implementing economic and fiscal reforms under its Extended Fund Facility (EFF) with the IMF, marked most recently by the staff-level agreement reached on the seventh and eighth reviews of the program. Disbursements under the EFF, which began in July 2019, amount to approximately US$3 billion so far, with an expected $1.2 billion likely to be allocated soon. The latest staff-level agreement, which is subject to approval by the IMF’s executive board, was reached following an extended period of discussions between the government and IMF officials. The agreement reflects the government’s increasing commitments made over recent weeks to fiscal consolidation in its fiscal 2023 budget, it added.

The Agency noted that Pakistan’s current government, which took office in April 2022 following a successful no-confidence vote against former Prime Minister Imran Khan, has adopted a variety of measures in order to stabilize its fiscal position and to more closely align with IMF program objectives. However, the current inflationary environment complicates the implementation of such policies. Achieving a primary fiscal balance surplus, and boosting its stock of foreign exchange reserves, will also be more difficult for the government to achieve against the current external backdrop.

It further stated that with parliamentary elections due by August 2023, the current government has limited time in which to implement meaningful economic reforms, especially those that may imperil electoral support for coalition members. Political uncertainty will remain elevated over the coming quarters, in our view.

The ratings on Pakistan remain constrained by a narrow tax base and domestic and external security risks, which are elevated. Although the country’s security situation has gradually improved over recent years, ongoing vulnerabilities weaken the government’s effectiveness and weigh on the business climate. Humanitarian and security conditions in neighbouring Afghanistan could pose additional risks to Pakistan’s domestic security in the years ahead.

Pakistan’s economy achieved a solid expansion in fiscal 2022, with real GDP growth hitting an estimated 5.5 percent on favourable base effect and a recovery in economic activity in line with the relaxation of pandemic-related restrictions. Nevertheless, growth momentum will be countered by an expected slowdown in the global economy, high inflation, and rapidly tightening financial conditions.

The Pakistani rupee’s recent depreciation against the U.S. dollar has also contributed to a continued stagnation in Pakistan’s nominal GDP per capita. “We forecast GDP per capita to stabilize just above $1,400 by fiscal 2025,” it added.

Pakistan’s security situation has improved moderately over the past 10 years. However, enduring domestic security risks, in combination with occasional tensions with India, and Pakistan’s extended land border with Afghanistan, pose challenges to Pakistan’s long-term economic outlook. These conditions, along with a shortfall in physical infrastructure, are hindrances against attracting foreign direct investment, the Agency noted.

The report noted Pakistan’s fiscal and external positions are under pressure from rising inflation and interest rates. We forecast the general government’s fiscal deficit will fall to 5.5 percent of GDP in the current fiscal year, versus an estimated 7.3 per cent of GDP in fiscal 2022. Although revenue has grown quickly since fiscal 2020, expenditure has also risen quickly as a result of rising debt service costs and intermittent efforts at mitigating the impact of rising commodity prices via subsidy schemes. Policymakers’ willingness and ability to scale back on these expenditure items will be critical to meeting ambitious targets set out in the IMF’s EFF agreement.

The rating agency noted that the Pakistan government introduced a series of fiscal measures in its latest budget, alongside the removal of fuel subsidies, in order to better align its fiscal program with program objectives. The latest IMF staff-level agreement, announced on July 13, entails a primary fiscal surplus equivalent to 0.4 per cent of GDP in fiscal 2023. Strong budgeted revenue growth will be supported by enhanced marginal income tax rates for high-earning individuals, a calibrated industrial “super tax,” and a higher effective tax rate for the banking sector, among various other schemes.

“We forecast the average annual change in net general government debt at 7 per cent of GDP from fiscal 2023 through to fiscal 2025, reflecting our expectations for gradually smaller shortfalls, in combination with a continued depreciation of the Pakistani rupee. These trends will keep Pakistan’s net debt stock high at about 75 per cent of GDP”, it added.

Pakistan’s unusually high interest expense relative to fiscal revenue is an additional constraint on our assessment of the government’s debt burden. Rising interest rates and a weaker rupee will likely push this ratio higher, toward 45 per cent of revenues, over the next few years. While Pakistan’s revenue reform measures and its economic recovery have helped to prevent a more aggressive deterioration in its interest burden dynamics, our forecast reflects heightened risk to the sustainability of the government’s debt stock.

Fitch downgrades Pakistan’s outlook to negative, sees 'considerable risks' to IMF programme

Following the IMF staff-level agreement, important bilateral partners, including China, the United Arab Emirates, and Saudi Arabia, may also take the stabilization of the reform program into consideration in their provision of funding to the government. However, fundamental pressure on Pakistan’s fiscal and external position is likely to persist over the next 12 months, owing in large part to global economic factors that are outside of the control of domestic policymakers.

Financial support from a contingent of multilateral and bilateral creditors, including the United Arab Emirates, the People’s Bank of China (PBoC), and Saudi Arabia, remains critical to Pakistan’s ability to meet high external financing needs. “We estimate total support from these three partners at $13.6 billion, and add this sum to the government’s total stock of debt. Additional support from bilateral partners could be increasingly contingent upon Pakistan’s ability to revitalize its EFF program with the IMF”, it added.

Combined support from Pakistan’s international partners remains crucial in meeting its external financing needs over the coming years. The country’s worsening current account dynamics will place additional pressure on its external financing conditions. We estimate that Pakistan’s current account deficit rose beyond 4.5 per cent of GDP in fiscal 2022, far beyond its 0.8 per cent shortfall in fiscal 2021, as a result of higher commodity prices, stronger import demand, and a weaker rupee. The higher current account deficit is placing additional downward pressure on Pakistan’s gross foreign exchange reserves, which fell to US$15.6 billion in April, compared with US$21.1 billion at the end of fiscal 2021.

Gross external financing needs, as well as, net external indebtedness, are set to rise against the backdrop of a more challenging external landscape, with narrow net external debt jumping above 150 per cent of current account receipts from fiscal 2022 onward. To calculate Pakistan’s usable reserves, we deduct approximately US$9.5 billion from gross reserves owing to the central bank’s borrowing position from the domestic commercial banking sector and bilateral partners. As gross reserves fall and borrowings remain elevated, we estimate that Pakistan’s usable foreign exchange reserves will fall to about US$2.8 billion in fiscal 2023, from approximately US$14.2 billion in fiscal 2021.

“We expect Pakistan’s foreign exchange reserves to remain heavily dependent upon the renewal of existing bilateral credit and commercial loan facilities, as well as, the potential extension of new ones, in order to offset its elevated current account deficit over the coming quarters. Pakistan’s external indebtedness remains high, with narrow net external debt forecast to average more than 180 per cent of current account receipts over the next few years. Although external aid is helping to meet immediate external financing requirements, it will also add to the debt stock”, it added.

Pakistan’s banking system is relatively small by international standards, with total bank assets comprising approximately 60 per cent of GDP. We do not have a Banking Industry Country Risk Assessment on Pakistan. However, its banking system appears stable, reflecting adequate liquidity and strong capitalization. Combining our view of Pakistan’s government-related entities and its financial system, we assess the country’s contingent fiscal risks as limited. That said, at more than 20 per cent of total system assets, Pakistan’s banking system bears an outsized exposure to the sovereign.

“We believe the State Bank of Pakistan’s (SBP) autonomy and performance have strengthened since the establishment of a monetary policy committee for rate-setting in January 2016. The SBP’s interest rate corridor helps the monetary transmission mechanism by providing directions for short-term market interest rates” the rating agency noted.

Earlier this year, Pakistan passed into law amendments to the SBP Act which affords additional independence to the central bank, in line with IMF program objectives. The central bank has also allowed the currency to float more freely with market forces over the past two years, which should mitigate the risk of currency-driven structural imbalances over the long term.

Pakistan is experiencing elevated CPI inflation, which stood at more than 20 per cent year on year in June 2022, as a result of rising food and energy prices. The central bank has assumed an active stance in tightening monetary policy, including a cumulative 525 bps worth of hikes to its policy rate since December 2021, in order to tamp down inflationary pressure and lean against continued depreciation of the rupee. We expect inflation to remain elevated for the remainder of this year, driven also in part by the weaker currency, before gradually moderating from 2023 onward. Nevertheless, Pakistan’s higher interest rate environment will place additional upward pressure on the government’s debt servicing costs over the next two to three years, given its large stock of local-currency-denominated debt, it added.

Copyright Business Recorder, 2022

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