Fitch Ratings has downgraded Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘B-‘ from ‘B’. Though it has maintained the Outlook as stable.
The credit rating agency has highlighted that the downgrade reflects heightened external financing risk from low reserves and elevated external debt repayments, as well as a continued deterioration in the fiscal position, with a rising debt/GDP ratio.
Fitch also forecasts GDP growth to fall to 4.2% in FY19, from a 13-year high of 5.8% in FY18, as monetary and fiscal tightening measures begin to weigh on activity.
In its report, the credit rating agency mentioned that a successful conclusion of ongoing negotiations on IMF support could help stabilize external finances, but the programme would then face a significant implementation risk.
Fitch reported that liquid reserves have continued to decline, reaching USD 7.3 billion as of 6 December 2018 – equivalent to 1.5 months of imports – despite significant stabilization efforts by the State Bank of Pakistan (SBP) and the new Pakistani government.
The credit rating agency projects high gross financing needs, with an expected narrowing of the current account deficit offset by higher external debt service payments relative to last year.
Fitch highlighted sovereign debt-service obligations over the next three years amount to USD 7 billion – 9 billion per year, including a USD 1 billion Eurobond repayment due in April 2019.
However, external debt servicing will stay high throughout the next decade, with China Pakistan Economic Corridor (CPEC)-related outflows set to begin in the early 2020s said the report.
The SBP has raised interest rates by a cumulative 425bp during 2018 and has allowed the rupee to fall by 24% against the US dollar since December 2017.
Fitch estimates the current-account deficit to narrow to 5.1% of GDP in the fiscal year ending June 2019 (FY19) and to 4.0% in FY20, from a revised 6.1% in FY18.
Rupee depreciation, lower oil prices and newly imposed import duties will drive a deceleration in imports, while exports are likely to strengthen gradually. However, this may not be sufficient to re-build the reserve buffers sustainably.
Bilateral financial assistance, including USD 3 billion in short-term financing from Saudi Arabia (in addition to USD 3 billion in deferred oil payments) along with undisclosed commitments from China and the UAE, has helped plug the near-term financing gap.
The government also requested an IMF programme in mid-October 2018, with progress already made in related discussions.
Fitch reported that successful negotiations could attract more stable and sustained financing by opening up the budget support from the World Bank and the Asian Development Bank, and by improving access to bilateral lending and global capital markets.
Fitch estimates that in the absence of an IMF programme, liquid foreign-exchange reserves would continue falling to USD 7 billion by FYE19.
It said that Pakistan’s debt/GDP ratio rose to 72.5% in FY18, from about 67% in FY17, due to rupee depreciation and a widening fiscal deficit.
Fitch projects that the debt ratio will rise further, to 75.6% of GDP in FY19, on additional rupee depreciation.
Debt is mainly denominated in local currency, but the pace of external borrowing has increased in the past two years. The government remains highly reliant on borrowing from the SBP and short-term treasury bill issuances, as domestic banks lack the appetite for longer maturity issues due to rising policy rates.
Fitch believes the fiscal deficit will narrow to 5.6% of GDP in FY19, from 6.6% in FY18, above the 5.1% target in the new government’s FY19 mini-budget, which rolled back the previous government’s tax relief plans, implemented new revenue measures and cut development expenditure.
The revenue growth in the 1st quarter of FY19 will remain subdued, noted Fitch, but said it would pick up modestly as the government’s policies come into place.
Fitch observed better fiscal coordination was planned via the Fiscal Coordination Committee between the federal and provincial governments.
The increase of losses in public-sector enterprises poses a contingent liability for the government. The so-called ‘circular debt’ (inter-company arrears) in the energy sector has continued to rise in the past few years and stands at about 3% of GDP due to inefficiencies, low tariffs and inadequate tariff collection.
The new government is planning to reduce the accumulation and stock of the circular debt.
The credit rating agency forecasts GDP growth to fall to 4.2% in FY19, from a 13-year high of 5.8% in FY18, as monetary and fiscal tightening measures begin to weigh on activity.
However, this remains above the current ‘B’ category median GDP growth of 3.5%.
Fitch projects that reduced infrastructure capacity constraints, particularly in the energy sector, following CPEC investments, along with improved national security, could support growth in the medium term.
It said that the inflation has risen due to significant rupee depreciation and higher energy prices.
Fitch expects inflation to increase to an average of 7.0% in FY19, from 3.9% in FY18. Credit growth in the banking sector remains robust as it poses limited risk to the sovereign, as capital capability is well above regulatory minimums and represents a small share of GDP.
Fitch said that the new government has an ambitious structural-reform agenda aimed at improving institutional governance and the business environment. This agenda could enhance medium-term policymaking and boost growth, but warned that there are significant implementation challenges. Entrenched vested interests, internal coalition dynamics and a strong opposition could prevent the enactment of broad-reaching reforms.
Domestic security has improved, with a decline in terrorist incidents and casualties. Nevertheless, ongoing domestic threats continue to weigh on investor sentiment cautioned Fitch.
Whereas Geopolitical tensions with neighbouring countries and issues around compliance with the intergovernmental Financial Action Task Force standards also pose risks said the credit rating agency.