Fitch warns external accounts pressure could constrain policy agenda for incoming govt

One of the biggest credit rating agencies in the world, Fitch Ratings, on Wednesday, said that incoming government will be under immediate pressure to arrest the deterioration in external finances and address fiscal challenges, while attracting enough external funding to meet its financing gaps.

Fitch Ratings, via a press release, expressed the view that in the short term, the advancement of the policy agenda, which includes confronting corruption, reducing inequality and expanding social services, will be limited since external and fiscal problems will be taking priority.

It is no secret that the current account deficit for Pakistan reached 5.6% of GDP in the fiscal year ended June 2018, compared to 4.7% by the end of the fiscal year 2017, while liquid foreign exchange reserves fell by almost $4 billion since December 2017, reaching to just over $10 billion by end of July 2018.

“The sharp rise in global risk aversion towards emerging markets, and a projected pickup in Pakistan's external debt obligations in 2019 are adding to financing pressures,” the rating agency said. “The fiscal deficit has also widened and is likely to well exceed our previous estimate of 6% of GDP in FY18, up from 5.8% a year earlier,” it added.

The rating agency, in January 2018, to reflect the rising external and fiscal pressures, had revised the Outlook on Pakistan’s ‘B’ rating to Negative from Stable.

The State Bank of Pakistan has already taken some steps, raising its policy rate by 175bp since January 2018 and introducing greater flexibility in the heavily managed rupee by allowing four separate depreciations since mid-December 2017, which resulted in a cumulative 17% decline against the US dollar. These measures have so far not been enough to prevent the widening of the large external financing gap, which has been bridged with support from China, including an agreement to provide USD2 billion in additional bilateral lending in July. The Saudi-backed Islamic Development Bank has also reportedly extended a USD4 billion loan.

The new government appears to recognise the urgency of the situation, with the likely incoming finance minister, Asad Umar, stating that "all options are on the table" and that the government will formulate a policy and financing path within six weeks. Fitch expects Pakistan to seek potential financing from several sources including China and multilateral development banks, and possibly the IMF. 

Pakistan has been a repeated user of IMF financing, entering 12 programmes since 1980. The IMF would probably require further fiscal and monetary tightening, greater exchange-rate flexibility, and wide-ranging structural reforms, which could also help attract other sources of financing. Moreover, the IMF has unique monitoring mechanisms to implement corrective policies, without which there will continue to be significant uncertainty over the medium-term sustainability of Pakistan's finances.

Negotiations over an IMF agreement could be complicated by loans linked to the China-Pakistan Economic Corridor (CPEC), part of China's Belt Road Initiative (BRI), particularly amid rising global geopolitical tensions. Recent statements from US Secretary of State Mike Pompeo suggest the US administration does not want IMF financing used to bail out Chinese lenders. US backing is not strictly required to secure an IMF programme, but the IMF board emphasises consensus decision-making. US pressure could lead to stricter programme conditionality, including the curtailment of CPEC projects and greater transparency in CPEC financing. 

The USD62 billion CPEC project makes Pakistan one of the largest recipients of BRI financing. These loans have financed imports of capital goods, which have in turn inflated the current account deficit. The loans will eventually need to be repaid or refinanced.