Moody’s Investors Service on Wednesday changed the outlook on Pakistan’s rating to negative from stable and affirmed the B3 local and foreign currency long-term issuer and senior unsecured debt ratings.
The international rating agency’s decision to change the outlook to negative is driven by heightened external vulnerability risk.
Moody’s reported that foreign exchange reserves have fallen to low levels and, absent significant capital inflows, will not be replenished over the next 12-18 months. Low reserve adequacy threatens continued access to external financing at moderate costs, in turn potentially raising government liquidity risks.
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Nevertheless the decision to affirm the B3 rating reflects Pakistan’s robust growth potential, supported by ongoing improvements in energy supply and physical infrastructure, which are likely to raise economic competitiveness over time. These credit strengths balance Pakistan’s fragile external payments position and very weak government debt affordability owing to low revenue generation capacity.
Concurrently, Moody’s has affirmed the B3 foreign currency senior unsecured ratings for The Second Pakistan Int’l Sukuk Co. Ltd. and The Third Pakistan International Sukuk Co Ltd. The associated payment obligations are, in our view, direct obligations of the government of Pakistan.
Pakistan’s Ba3 local currency bond and deposit ceilings remain unchanged. The B2 foreign currency bond ceiling and the Caa1 foreign currency deposit ceiling are also unchanged.
The short-term foreign currency bond and deposit ceilings remain unchanged at Not-Prime. These ceilings act as a cap on the ratings that can be assigned to the obligations of other entities domiciled in the country.
Moody’s expects Pakistan’s external account to remain under significant pressure. The coverage by foreign exchange reserves of imports will likely fall further from already low levels, while coverage of external debt payments due will weaken from currently adequate levels.
The international rating agency noted that external vulnerability risks are related to Pakistan’s sizeable current account deficit, which Moody’s expect will only narrow slightly to around 4-4.3% of GDP over the next few years, after an expected 4.6% in fiscal 2018 (FY2018, fiscal year ending June 2018) and compared to an average deficit of around 1.5% between FY2014 and FY2016.
Moody’s expects the government’s tax amnesty scheme, which expires in June 2018, to have a modest impact of around $2-3 billion in foreign exchange inflows.
Moody’s stated that Pakistan’s external financing gap to be met by increased foreign currency borrowing, mainly by the government.
The authorities have so far allowed the Pakistani rupee to depreciate by a total of 15% against the US dollar since December 2017, raised policy rates by a total of 75 basis points, and imposed regulatory duties on imports of nonessential goods.
They highlighted that these measures will contribute to somewhat lower growth, at 5.2% on average over the next two fiscal years, from an expected 5.8% in FY2018, and higher inflation at 7.0% in FY2019, from around 4% in FY2018.
Further currency depreciation, higher policy rates, fiscal tightening, and/or higher regulatory duties would likely weigh further on growth and raise inflation above Moody’s current projections.
Pakistan’s External Vulnerability Indicator, the ratio of external debt payments due over the next year plus total nonresident deposits over one year to foreign exchange reserves, will rise to over 120% in FY2019 and further in FY2020, from around 80-85% at the start of FY2018.
Pakistan’s relatively strong growth potential, enhanced by investment that strengthens and stabilizes power supply, provides the economy with some capacity to absorb external or domestic shocks.
Moody’s expects GDP growth in Pakistan to remain robust, above 5%. Pakistan’s growth potential has risen in part with the gradual elimination of the country’s chronic energy shortage, which encourage investment in other sectors.
It expects the ongoing implementation of CPEC-related infrastructure projects to raise the country’s growth potential further, by improving road and rail connectivity within Pakistan, and allowing it to function as a transport and logistics hub under China’s Belt and Road Initiative.
Moody’s expects government revenue to remain around 16% of GDP over the next two fiscal years. They agency expects the government’s fiscal deficit to remain around 5% of GDP in FY2019 and FY2020, after a projected deficit of 5.8% in FY2018.
Finance Ministry Response
In response to Moody’s decision, Ministry of Finance issued a statement that said:
Moody’s has reaffirmed Pakistan’s local and foreign currency long-term issuer and unsecured debt ratings as B3.
The statement highlighted that the government is fully aware of the challenges facing its external account and short to medium term remedial measures are already being put in place.
It also highlighted that the government is fully committed to maintain sound policies with the aim of sustaining macroeconomic stability and accelerating economic growth. The growth trajectory achieved over recent years is testimony to the success of the Government’s reforms agenda
To curtail aggregate demand, interest rate has been enhanced by 75 basis points since January 2018. The added exchange rate flexibility is expected to contribute towards containing the current account deficit. As exports pick up, 13.3 percent increase in July-April period, and #CPEC related imports peak out, the current account deficit is expected to peak this year and decline in the coming years. FDI and remittances have also rebounded with an increase of 2.5 percent and 3.9 percent respectively during current financial year.
It also pointed out that the government has also successfully decelerated the import bill through the imposition of regulatory duties on non-essential and luxury items. Following clearance from the Supreme Court of Pakistan, the recently announced Amnesty Scheme is also expected to bring additional inflows.
The statement reassured that Pakistan has sufficient foreign exchange reserves to meet its obligations on account of external debt repayments and that the government is, therefore, confident of the outlook on its external account.
junk rating is going to get junkier!