Fitch downgrades Pakistan's rating to CCC+ from B-

October 21, 2022 (MLN): Fitch Ratings on Friday downgraded Pakistan's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'CCC+' from 'B-'. 

Fitch typically does not assign Outlooks to sovereigns with a rating of 'CCC+' or below.

The downgrade reflects further deterioration in Pakistan's external liquidity and funding conditions and the decline of foreign exchange (FX) reserves, Fitch Ratings stated in a report. 

This is partly a result of widespread floods, which will undermine Pakistan's efforts to rein in twin fiscal and current account deficits. The downgrade also reflects our view of increased risks of policies potentially undermining Pakistan's IMF programme and official financial support, it added. 

Furthermore, the liquid net FX reserves of the State Bank of Pakistan (SBP) were about $7.6 billion by October 14, 2022, or about a month of current external payments, down from more than $20bn at the end-August 2021. Falling reserves reflect large, albeit, declining current account deficits (CADs), external debt servicing, and earlier FX interventions by the SBP.

Before stabilizing in the week of October 14, reserves had been falling every week since the disbursement of $1.2bn from the IMF in the week of September 2, upon the completion of the 7th and 8th reviews of Pakistan's Extended Fund Facility (EFF).

It further stated that the CAD reached $17bn (4.6% of GDP) in the fiscal year to June 2022 (FY22), driven by soaring oil prices and higher non-oil imports on strong private consumption.

Fiscal tightening, higher interest rates, and measures to limit energy consumption and imports underpin our forecast for the CAD to narrow to $10bn (2.7% of GDP) in FY23, despite the hit to export revenue and import needs after the recent floods. Lower imports and commodity prices helped to narrow the CAD in recent months, to about $300 million in September.

Meanwhile, Pakistan's external public debt maturities in FY23 are over $21bn, mostly to bilateral and multilateral creditors, which mitigates rollover risks, and there are already agreements to roll over some of these. The authorities estimate the flood damage at $10bn-30bn, but reconstruction costs are likely to be lower, as is the impact on Pakistan's twin deficits.

Pakistan recently received funding commitments of USD2.5 billion from the World Bank and Asian Development Bank, according to the authorities, although we understand that much of this is repurposed from ongoing programs. It remains unclear to what degree the IMF will be able to relax Pakistan's program targets or augment Pakistan's access under the EFF.

Fitch Ratings assumes that Pakistan will continue to receive disbursements under its IMF programme, but risks to this have risen. Fuel-price cuts from 1 October may not be compatible with commitments to the IMF.

A quarterly electricity tariff adjustment due in October has yet to happen. The new finance minister has reaffirmed their commitment to the programme, but prefers a strong exchange rate, and may revisit the SBP law that was amended in early 2022 to grant the SBP greater autonomy, as previously agreed with the IMF, it noted.

The 'CCC+' Long-Term Foreign-Currency IDR also reflects the following factors:

Debt Relief Raised, Rejected: The previous finance minister said before resigning that Pakistan would seek debt relief from non-commercial creditors, although he reiterated the intention to repay the USD1 billion bond due in December 2022. Prime Minister Shehbaz Sharif also appealed for debt relief within the Paris Club framework. More recently, however, the Minister of Finance publicly ruled this out.

Pakistan's debt to private creditors (or official Paris Club creditors) is only a small fraction of the total and the authorities maintain that they have no intention to restructure debt to private creditors.

Political Volatility: Former Prime Minister Imran Khan, who was ousted in a no-confidence vote on 10 April, continues to put political pressure on the government, organizing protests across the country calling for early elections. Mr Khan's PTI party won by-elections in the key Punjab province in July, defeating the incumbent PML-N, and PTI won more national and provincial seats in by-elections on 17 October. Regular elections are due in October 2023, creating the risk of policy slippage after the conclusion of the IMF programme due in June.

Fiscal Worsening, Consolidation: The fiscal deficit widened to 7.9% of GDP (over PKR5 trillion) in FY22, from 6.1% in FY21. Tax reductions and subsidies on fuel and electricity account for most of the fiscal deterioration; these were introduced by the previous government in February and lasted until June. We expect a narrowing of the deficit to 6.2% of GDP (about Rs5 trillion or $23bn) in FY23, driven by some spending restraints and higher taxes.

Debt to Decline: Pakistan's debt/GDP ratio was 73% at FYE22, broadly in line with the current 'B' median. We expect debt/GDP to fall to 70% in FY23 and continue decreasing, helped by high inflation and a modest primary deficit. A low FX exposure at just over 30% of total debt limits the negative impact of currency depreciation on debt dynamics. Nevertheless, debt/revenue (at over 600% in FY22) and interest/revenue (at about 40%) are significantly worse than the 'B' median. This largely reflects low general government revenue of 12% of GDP in FY22.

High Inflation, Monetary Tightening: Consumer price inflation averaged 12.2% in FY22 but accelerated to 21.3% YoY (6.3% mom) in June and averaged 25% YoY (1.8% mom) in July-September, driven by hikes to petrol and electricity prices. The SBP maintained its policy rate at 15% at its last meeting on 10 October, after cumulative rate hikes of 800bp in the latest tightening cycle.

Slowing Growth: We forecast GDP growth to decelerate to about 2% in FY23, from 6% in FY22, amid fiscal and monetary tightening, high imported inflation, a weak external demand outlook, and flood-related disruptions. This is broadly in line with the government's forecast, down from its initial target of 5% and a 3.5% forecast in the IMF programme. The 2010-2011 floods contributed to Pakistan's weak recovery after the global financial crisis.

ESG - Governance: 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 low WBGI ranking at the lower 22nd percentile.

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