Moody's changes Pakistan banking outlook to positive vs stable

March 12, 2025 (MLN): In a significant development for Pakistan’s banking sector, global rating agency Moody’s has upgraded the country’s banking outlook from stable to positive.

“We have revised our outlook on Pakistan’s banking system to positive from stable, reflecting the sector’s resilient financial performance and improving macroeconomic conditions from the extremely weak levels observed a year ago,” the agency stated.

Moody’s highlighted that this positive outlook aligns with the Government of Pakistan’s (Caa2 positive) rating outlook, given banks' substantial exposure to sovereign debt.

Government securities constitute nearly half of total banking assets, as per the press release.

However, the agency also cautioned that Pakistan’s long-term debt sustainability remains a concern due to its fragile fiscal position, high liquidity risks, and external vulnerabilities.

The credit rating agency projected Pakistan’s economic growth at 3% in 2025, up from 2.5% in 2024 and a contraction of -0.2% in 2023.

Additionally, inflation is expected to ease significantly, declining to approximately 8% in 2025 from an average of 23% in 2024.

Moody’s anticipates a slowdown in problem loan formation as borrowing costs and inflation decrease.

However, net interest margins are expected to narrow due to interest rate cuts.

Banks are likely to maintain adequate capital buffers, supported by modest loan growth and stable cash generation, despite high dividend payouts.

The agency attributed the improved outlook to a better operating environment.

“Pakistan’s economic prospects are improving from a weak base, with enhanced government liquidity and external stability compared to 2024,” it noted.

The report pointed to Pakistan’s 37-month, $7 billion IMF Extended Fund Facility, approved in September 2024, as a reliable source of external financing over the next few years.

Moody’s forecasts GDP growth of 3% in 2025 and 4% in 2026, driven by a 10-percentage-point cut in interest rates since the monetary easing cycle began in June 2024.

Lower inflation and interest rates are expected to boost private-sector spending and investment.

Despite these positive trends, the agency highlighted risks associated with banks' high exposure to government securities, which accounted for 55% of total banking assets as of September 2024.

While non-performing loans rose to 8.4% from 7.6% the previous year, loans still represent only 23% of total banking assets.

With the removal of the Advance-to-Deposit Ratio (ADR) tax for 2025, banks are under less pressure to expand financing, especially as demand remains relatively subdued despite lower borrowing costs.

Previously, the ADR-linked tax incentive required banks to achieve a 50% ADR by the end of 2024, with non-compliance resulting in additional taxes ranging from 10% to 15%.

Following recent interest rate cuts that lowered the policy rate to 12%, Moody’s expects banks’ profit margins to shrink.

Pakistani banks primarily generate earnings from interest on government securities, which now yield lower returns than in the previous year.

While reduced funding costs will partly offset the downward repricing of assets, increased business activity and non-interest income are unlikely to fully compensate for margin compression.

As a result, the agency forecasts banks’ return on assets to moderate to around 0.9%-1.0% in 2025.

Moody’s also noted an improvement in Pakistan’s foreign exchange (FX) stability, citing an increase in SBP’s FX reserves following the IMF program’s revival.

In a previous report from November 2024, the agency projected that interest costs in Pakistan would constitute nearly 40% of total spending in 2025.

This is a significant increase compared to around 25% in 2021.

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