ISLAMABAD: Fitch Ratings has upgraded Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to “CCC” from “CCC-” while saying the upgrade reflects Pakistan’s improved external liquidity and funding conditions following its Staff-Level Agreement (SLA) with the IMF on a nine-month Stand-by Arrangement (SBA) in June.
Fitch typically does not assign Outlooks to sovereigns with a rating of “CCC+” or below, it added.
“We expect the SLA to be approved by the IMF board in July, catalysing other funding and anchoring policies around parliamentary elections due by October. Nevertheless, programme implementation and external funding risks remain due to a volatile political climate and large external financing requirement,” the rating agency noted.
It further stated Pakistan has recently taken measures to address shortfalls in government revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate, including import financing restrictions. These issues held up the last three reviews of Pakistan’s previous IMF programme, before its expiry in June.
Most recently, the government amended its proposed budget for the fiscal year ending June 2024 to introduce new revenue measures and cut spending, following additional tax measures and subsidy reforms in February. The authorities appeared to abandon exchange-rate management in January 2023, although guidelines on prioritising imports were only removed in June.
Pakistan has an extensive record of going off-track on its commitments to the IMF. We understand the government has already made all the required policy actions under the SBA. Nevertheless, there is still scope for delays and challenges to implementation as well as new policy missteps ahead of the October elections and uncertainty over the post-election commitment to the programme.
The IMF board approval of the SBA will unlock an immediate disbursement of $1.2 billion, with the remaining $1.8 billion scheduled after reviews in November and February 2024. Saudi Arabia and the United Arab Emirates have committed another $3 billion in deposits, and the authorities expect $3-5 billion in other new multilateral funding after the IMF agreement.
The SBA should also facilitate the disbursement of some of the $10 billion in aid pledges made at the January 2023 flood relief conference, mostly in the form of project loans ($2 billion in the budget).
The authorities expect $25 billion in gross new external financing in fiscal year 2024, against $15 billion in public debt maturities, including $1 billion in bonds and $3.6 billion to multilateral creditors.
The government funding target includes $1.5 billion in market issuance and $4.5 billion in commercial bank borrowing, both of which could prove challenging, although some of the loans not rolled over in fiscal year 2023 could now return. The $9 billion in maturing deposits from China, Saudi Arabia and the UAE will likely be rolled over, as in fiscal year 2023.
Pakistan’s current account deficit (CAD) has narrowed sharply, driven by earlier restrictions on imports and FX availability, tighter fiscal and economic policies, measures to limit energy consumption and lower commodity prices.
Pakistan posted current account surpluses in March-May 2023, and we forecast a CAD of about USD4 billion (1 per cent of GDP) in FY24, after USD3 billion in FY23 and over USD17 billion in FY22. Our forecast CAD is lower than the USD6 billion in the budget, on the assumption that not all of the planned new funding will materialise, constraining imports.
The CAD could widen more than we expect, given continued reports of import backlogs, the dependence of the manufacturing sector on foreign inputs, and reconstruction needs after last year’s floods. Nevertheless, currency depreciation could limit the rise, as the authorities intend for imports to be financed through banks, without recourse to official reserves.
Remittance inflows could also recover after partly switching to unofficial channels to benefit from more favourable parallel market exchange rates.
The rating agency stated that liquid net FX reserves of the State Bank of Pakistan have hovered around USD4 billion since February 2023, or less than a month of imports, down from a peak of more than USD20 billion at end-August 2021.
The collapse in reserves reflected large CADs, external debt servicing and earlier FX intervention by the central bank. We expect a modest recovery for the rest of FY24 on new external financing flows, although these flows will also lead to a renewed widening of the CAD.
Fitch Ratings further stated that protests by supporters of former prime minister Imran Khan and his PTI party sharply intensified in May as Khan was briefly arrested on corruption charges, culminating in attacks on army facilities. In the ensuing crackdown, a large number of PTI members were arrested, with several high-ranking PTI politicians quitting politics. Nevertheless, the enduring popularity of Khan and PTI creates policy uncertainty around elections.
“We expect the consolidated general government (GG) fiscal deficit to widen to 7.6% of GDP in FY24, from an estimated 7.0% in FY23, driven by higher interest costs on domestic debt, which accounts for the difference between our forecast and a GG deficit of 7.1% of GDP in the revised FY24 budget statement (with a lower figure of 6.5% in the medium-term fiscal framework). Fiscal consolidation will drive a slight improvement in our forecast GG primary deficit to 0.1% of GDP in FY24, from 0.5% of GDP in FY23”, it added.
The GG debt/GDP of 74 percent at FYE23 is in line with the median for “B”, “C” and “D” rating category sovereigns and debt dynamics are broadly stable owing to high nominal growth over the medium-term. Nevertheless, debt/revenue (over 600 percent) and interest/revenue (nearly 60 per cent) are far worse than that of peers.
The finance minister recently said that Pakistan would seek maturity extensions on loans by non-Paris club bilateral creditors while reaffirming the government’s commitment to timely debt service. We understand that such maturity extensions would mostly relate to loans and deposits by China, Saudi Arabia and the UAE, which are already regularly rolled over.
In 2022, the prime minister and former finance minister raised the possibility of seeking debt relief from non-commercial creditors, including the Paris Club, but the authorities now appear to have moved away from this.
Should Paris Club debt treatment be sought, Paris Club creditors are likely to require comparable treatment for private external creditors in any restructuring. 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.
These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Pakistan has a WBGI ranking at the lower 22nd percentile. Increasing likelihood of default, for example, renewed deterioration in external liquidity conditions that could result from delays in IMF disbursements, or indications that the authorities are considering debt restructuring.
The rating agency stated that factors that could, individually or collectively, lead to positive rating action/upgrade include; strong performance against IMF programme conditions, ensuring continued availability of funding, rebuilding of foreign-currency reserves and further easing of external financing risks.
Copyright Business Recorder, 2023