S&P Global keeps Pakistan’s rating at ‘CCC+’

July 31, 2024 (MLN): S&P Global Ratings has affirmed Pakistan's long-term sovereign credit rating at 'CCC+' and short-term rating at 'C', maintaining a stable outlook.

This decision reflects a balance between the challenges posed by Pakistan's external liquidity and fiscal performance, and the anticipated continued support from multilateral and bilateral partners over the next 12 months.

Despite economic challenges, international support and fiscal measures provide a degree of stability to the country's financial outlook.

"We could lower our ratings if Pakistan's external indicators deteriorate rapidly or fiscal deficits widen to exceed the domestic banking system's financing capacity, to the extent that the government's willingness or ability to service its commercial debt is diminished," S&P said in its statement.

One potential indication of domestic financing stress would be further increases in the government's interest burden, which we estimate will exceed 45% of government revenues over the next few years.

"Conversely, we may raise our ratings if Pakistan's external and fiscal positions improve materially from current levels," the statement further reads.

 Signs of improvement could include a sustained rise in foreign exchange reserves, a reduction of Pakistan's debt-service costs relative to revenues and a lengthening of debt maturities.

Pakistan has shored up its foreign reserves over the last 12 months and near-term default risks have lessened. However, the rating agency believes the country remains reliant upon favourable macroeconomic and financial developments to meet its obligations over the long term.

"Sustained external concessional help will be key to rebuilding buffers, in our view," it said. Strong foreign fund inflows and moderate current account deficits would likely be required for Pakistan to restore its external buffers.

Pakistan continues to face high gross external financing needs, vulnerabilities to energy price developments, and the availability and timing of foreign support.

A notable inflow of funds from the International Monetary Fund (IMF) and prospective rollovers with Saudi Arabia, the United Arab Emirates (UAE), and China, will support Pakistan in managing its external financial requirements over the next six to 12 months.

The rating agency expects the ratio of government debt to GDP and budgetary deficits to remain elevated.

In combination with continued high domestic interest rates, this means that over 50% of government receipts will likely be used to service debt in fiscal 2025 (July 1, 2024-June 30, 2025), with a gradual reduction in the government's cost of borrowing in subsequent years. Pakistan's interest servicing-to-revenue ratio remains one of the highest globally among rated sovereigns.

According to recent media reports, the government is in the early stages of renegotiating the terms of certain external loans to its power sector.

"We do not consider the restructuring of official (non-commercial) debt as a default event. Should these power sector loans be restructured and we view them as official debt, this will not constitute a sovereign default and may support the reduction of Pakistan's debt servicing burden," the statement further added.

Pakistan's economy grew 2.4% in fiscal 2024, having recovered from the impact of severe floods. Agriculture--a critical sector accounting for 25% of economic output--recovered due to improved crop yields.

This was counterbalanced by underwhelming industry and services growth. GDP growth will remain modest in the current fiscal year at 3.5%, as elevated prices and daunting reform measures will weigh on economic activities; prices are gradually declining, however.

The Pakistani rupee's depreciation against the U.S. dollar in recent years has also contributed to a sustained stagnation in the country's nominal GDP per capita.

Coupled with lower real GDP growth expectations, the agency forecast GDP per capita will stabilize just below US$1,700 in fiscal 2026.

The government completed the Stand-By-Arrangement (SBA) with the IMF in April 2024. Disbursements under the SBA, which began in July 2023, totalled approximately $3 billion. The IMF disbursement, in addition to new deposits from bilateral partners, has helped to rebuild Pakistan's liquid foreign exchange reserves from critical lows early last year.

Pakistan and the IMF have since reached a new Staff Level Agreement (SLA) on a 37-month Extended Fund Facility (EFF) announced on July 12, 2024.

The financial support under the EFF will be US$7 billion, which is currently subject to the approval of the IMF board. The performance requirements of this program are a continuation and extension of those set in the SBA.

Meeting the EFF conditions will be critical for Pakistan to receive the disbursements in the coming quarters.

Persisting inflationary pressures, coupled with modest economic activity, continue to complicate the implementation of measures to consolidate the government's wide fiscal deficit. Inflation averaged 23.4% for fiscal year 2024, albeit lower than 29.2% in the previous fiscal year.

The fiscal consolidation efforts of the government will be eclipsed by sustained high inflation till it recedes substantially.

The newly formed coalition government, in the aftermath of the February 2024 general elections, appointed Shehbaz Sharif from the Pakistan Muslim League-Nawaz (PML-N) party as the prime minister, for the second time since 2022.

"We expect political uncertainty to remain high owing to a fractious political environment. The government's ability to navigate the necessary reform implementation under the IMF program without significant social unrest, will have significant bearing on policy efficacy over the coming quarters," it said.

Pakistani politics has been in a state of flux since the ouster of former Prime Minister Imran Khan of the Pakistan Tehreek-e-Insaf (PTI) party in a parliamentary no-confidence motion in April 2022.

The political turmoil has hampered the government's reform efforts to deal with economic challenges in the last two years and has damaged sovereign credit metrics.

S&P Global believes a more stable political environment in Pakistan is likely an important precondition to repairing the government's creditworthiness.

The ratings on Pakistan remain constrained by elevated domestic and external security risks. The country's security situation has improved since the early 2010s, but the potential to deteriorate in the future remains.

Possible border tensions with India and Afghanistan could also have a short-term impact on economic sentiments.

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