The Standard & Poor (S&P) Global Ratings has lowered its long-term sovereign credit rating for Pakistan to 'B'- from 'B' on diminished growth prospects, elevated external and fiscal stresses, amid an ongoing deterioration in the country's broad macroeconomic settings. The S&P Global Ratings in its latest report on Pakistan states that Pakistan's economic outlook, as well as its external position has deteriorated well beyond its previous expectations. With the weaker economic settings, and limited progress in addressing fiscal imbalances following elections in mid-2018, it is believed that prospects for a rapid recovery in fiscal and external settings are now diminished.
S&P Global Ratings has also lowered the long-term issue rating on senior unsecured debt and sukuk trust certificates to 'B'- from 'B' and affirmed its 'B' short-term sovereign rating. It further states that more modest growth prospects and limited reserve buffers will continue to challenge the country's external position, even as the government receives financial aid from various partners. Negotiations with the International Monetary Fund (IMF) have taken longer than anticipated, and it is believed the reform timeline will be more protracted in nature. The government's protracted negotiations with the IMF suggest that any resulting reforms, whether under the programme or otherwise, will be less expedient than previously anticipated.
The stable outlook reflects the expectations that Pakistan will secure sufficient financing to meet its external obligations over the next 12 months, and that neither external nor fiscal metrics will deteriorate well beyond the current projections.
"We may raise our ratings on Pakistan if the economy materially outperforms our expectations, strengthening the country's fiscal and external positions. Conversely, 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 expected", maintained the S&P Global Ratings.
Fiscal consolidation will be challenging as the economy slows owing to a paucity of growth drivers, and as the stimulus from China-Pakistan Economic Corridor (CPEC) investment fades. Although it is believed Pakistan will benefit over the long term from the associated improvements to its infrastructure, this will be counterbalanced by heightened fiscal and external stresses over the next few years.
The report further states that the government led by Pakistan Tehreek-e-Insaf (PTI) has yet to introduce fiscal measures that are sufficient to bring about a substantial improvement in the general government deficit. Though the government in October 2018 introduced new budget measures that will increase revenue from petroleum products and infrastructure development, among others, they believe that additional measures would be necessary in order to bring about a more meaningful decline in the fiscal deficit. The second mini-budget presented in January should be marginally supportive of the economy, but is unlikely to have a significant impact on fiscal imbalances.
The ratings on Pakistan remain constrained by a narrow tax base and domestic and external security risks, which continue to be high. 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. Change in government is yet to yield serious reform push. Although Pakistan's new government has publicly acknowledged the necessity of economic and fiscal reform, progress has been slower than anticipated.
It further states that Pakistan's very low income level remains a rating weakness. Inadequate infrastructure and security risks continue to act as structural impediments to foreign direct investment and sustainable economic growth. The 2018 general elections have thus far not elicited a significant improvement in Pakistan's economic environment. Despite acknowledgment by senior administration officials that Pakistan must embrace hard-hitting economic and fiscal reforms to avert a balance of payments and broader economic crisis, it is believed that imbalances will remain elevated over the next two years. Although no single party earned a majority of the votes in July 2018's general elections, the PTI's leading vote share was sufficient to propel party chairman Imran Khan to the post of prime minister in the newly formed coalition government.
Pakistan is facing considerable external and fiscal pressure following a significant rise in both the general government fiscal and current account deficits in the fiscal year ended June 2018.
These metrics have deteriorated since the completion of an Extended Funding Facility (EFF) reform program with the IMF in September 2016, leading the current government to seek financial and technical assistance from a variety of bilateral and multilateral parties. Against its previous expectations, they now believe that these difficulties will persist for some time, and that key metrics will worsen further through 2019. In order to meet the economy's elevated external funding needs, the government has reportedly secured foreign exchange support of approximately $3 billion each from the United Arab Emirates (UAE) and Saudi Arabia, along with deferred payments of $3.2 billion from each country for 2019 oil imports. These funds will help to alleviate acute external stresses and to supplement the central bank's limited foreign exchange reserves.
Pakistan's GDP per capita is estimated at just over $1,500 in 2018, which is in the bottom 10 percent of all sovereigns rated by S&P Global Ratings. The forecast of annual real GDP growth has revised downward to an average 3.6 percent over 2019-2022. Pakistan's per capita GDP growth is somewhat lower, at about 1.5 percent, due to a fast-growing population. The weaker growth projections mainly reflect the diminishing stimulatory impact of the investments associated with the CPEC, negative fiscal impulse as the government looks to rein in its deficit, and declining economic sentiment.
Although they believe CPEC energy projects such as coal, solar, hydroelectric, liquefied natural gas, and power transmission will be supportive toward economic activity over the long run, 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 long-lasting hostility with neighboring India and Afghanistan. These conditions, along with inadequate infrastructure, mainly in transportation and energy, are additional bottlenecks to foreign direct investments. The former PML-N government improved the security situation, and it is expected the PTI government to continue this positive momentum. Although progress has been made toward addressing these shortcomings, they believe there is much more to be done before we can see considerable uplift to the business climate.
Infrastructure investments and energy vulnerabilities have contributed to a significant weakening in external metrics. Pressure on external accounts will rise further in 2019.
"We forecast net general government debt to rise toward 70.2 percent of GDP by the end of fiscal 2022, with slower GDP growth and still-elevated deficits. Pakistan's interest servicing burden will remain elevated at an average of 32.4 percent of revenues", maintained the report. Over the near term, deferred payments on oil imports from the UAE and Saudi Arabia, with an estimated total value of $6.4 billion, will help to smooth pressing external financing needs. But more will need to be done to stem this vulnerability over the medium term, especially on export promotion and energy security.
Pakistan's current account deficit widened again to 6.1 percent of the GDP in the fiscal year ended June 2018 from 4.1 percent the year before and just 1.7 percent in 2016. The widening of the deficit was due to a strong rise in imports, without a correspondingly high growth in exports, with higher energy prices and the associated deterioration in Pakistan's terms of trade exacerbating the shortfall in the current account deficit. Remittances were roughly flat for the second year in a row in 2018, exhibiting limited upside despite stabilization in the Gulf countries.
The current account deficit is expected to decline somewhat over the next two years with energy prices falling and the economy slowing, Pakistan's external financing and indebtedness metrics remain stressed. Pakistan's high degree of external stress is marked by a significant rise in the economy's gross external financing needs relative to its current account receipts and useable reserves; "we forecast this ratio will climb to 151.1 percent at the end of fiscal 2019, versus approximately 131 percent in the previous year," the report warns.
The report has further projected that the country's narrow net external debt will rise to more than 170 percent of current account receipts, from just below 140 percent in the prior year. Though external aid will help to meet immediate payment needs, indebtedness will continue to rise in kind. Pakistan's fiscal profile has deteriorated beyond previous expectations and they have yet to observe policy initiatives sufficient to meaningfully reverse this trend. Change in net general government debt rose to 9.4 percent in fiscal 2018 versus 5.6 percent in the previous year, largely owing to the government's higher fiscal deficit and the depreciation of the Pakistani rupee.
"The new government has elucidated its aim to consolidate its fiscal accounts; we believe progress will be diminished by political constraints, especially in view of more difficult economic circumstances. We forecast the average annual change in net general government debt at 5.9 percent of GDP through 2022, which is elevated versus our previous expectations", maintained in the report. Pakistan's unusually high level of interest expense relative to fiscal revenue is an additional constraint on its assessment of the government's debt burden. Interest expense consumes nearly a third of government revenue, partly a function of its narrow tax base. Pakistan's ratio of tax revenue to GDP remains one of the lowest among sovereigns that they rate.
Pakistan's banking system is relatively small by international standards, with total bank assets comprising approximately 59 percent of the GDP. "We do not have a Banking Industry Country Risk Assessment on Pakistan. However, its banking system appears stable, reflecting its high profitability, 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 percent of total system assets, Pakistan's banking system bears an outsized exposure to the sovereign", maintained by the S&P Global Ratings.
The report further states that State Bank of Pakistan's (SBP) autonomy and performance has strengthened, since the setup 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. This framework, combined with the cyclical boost from lower food and energy prices, should keep inflation in check-averaging about 5.5 percent over our forecast horizon. Reduced budget financing by the SBP would also assist in cutting inflationary pressure.
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