Fitch Affirms Pakistan’s Long Term Rating at “B-” With a Stable Outlook

Fitch Ratings has affirmed Pakistan’s long-term foreign-currency issuer default rating (IDR) at ‘B-‘ with a stable outlook.

Pakistan’s ratings reflect challenging external finances and low reserve coverage, high public debt, and weak governance indicators.

Recent policy actions, including an agreement with International Monetary Fund (IMF) staff on a forthcoming program, should ease external finance risks, but reserve levels will take time to rise and the program will face significant implementation risks.

Policy measures by the authorities are driving a sizeable narrowing of the current account deficit. Fitch forecasts the current account deficit to narrow to 3 percent of GDP in the fiscal year ending June 2020 (fiscal year 20) from a peak of 6.3 percent in the fiscal year 2018, largely through import compression.

The State Bank of Pakistan (SBP) has raised its policy rate by 650bp since January 2018, including a 150bp hike on 20 May 2019, and has allowed the rupee to depreciate by nearly 30 percent against the US dollar since mid-December 2017.

These developments have lowered the trajectory of gross external financing needs and improved the external finance outlook. Nevertheless, Fitch expects external debt repayments to remain high over the medium term.

The company expects sovereign external debt service alone to be around USD8 billion-9 billion per annum in the coming years, particularly in light of the recent large upswing in external borrowing. In addition, repayments related to loans under the China-Pakistan Economic Corridor are set to pick up in the early 2020s.

Fitch says the forthcoming 39-month Extended Fund Facility with the IMF of around USD6 billion, announced in a staff level agreement in early May, would reduce external financing pressures and facilitate the rebuilding of reserve buffers. The program, if approved by the Executive Board as expected in early July, would also catalyze financing from the World Bank and the Asian Development Bank and improve global capital-market access.

It forecasts that reserves will begin rising during the fiscal year 2020 on the back of the improved access to external financing. Liquid foreign-exchange reserves were still low, at $7.8 billion (1.7 months of import coverage) as of 3 June 2019, despite $7.2 billion in the disbursed balance of payments support from Saudi Arabia, the United Arab Emirates, and China since last November. The SBP’s move to devalue the exchange rate since late-2017 will also support the rebuilding of reserves.

The authorities’ policy adjustments and the broader structural reform agenda should further support near-term macroeconomic rebalancing and could improve governance and the business environment over the medium term. However, reforms could prove politically challenging to implement. Risks around compliance with IMF targets are underscored by the uneven adherence to past programs.

Fitch maintained that public finances are a weakness for Pakistan’s credit profile and continued to deteriorate in the fiscal year 2019. It is estimated that the general government deficit widened to 7.3% of GDP in the fiscal year 2019 primarily due to significant underperformance of revenues. Slow economic growth and one-off tax relief measures, which are set to expire, kept revenue growth essentially flat. Expenditure continued to increase, but at a slower pace than in the fiscal year 2018.

The government’s fiscal year 2020 budget, released on 11 June, outlined a consolidation plan primarily based on revenue-raising measures, including removing tax exemptions, tax increases, and improved tax administration. Expenditure will rise on higher interest payments and the government plans to support social and development spending to offset the negative effects of macroeconomic adjustment.

In its agreement with IMF staff, the authorities committed to achieving a primary deficit of 0.6% of GDP in the fiscal year 2020, which entails an estimated 1.6 percentage point of GDP consolidation in the primary deficit relative to the fiscal year 2019.

The general government fiscal deficit will remain high at 7.1 percent in the fiscal year 2020. Meeting revenue targets in the context of sluggish growth could prove challenging, but the government is likely to lower expenditure relative to the budget to meet the primary deficit target. Fiscal performance at the provincial level is also a downside risk to the outlook and improved fiscal coordination with the provinces is important to consolidation efforts.

Fitch estimated that general government debt to GDP will rise to 77.4 percent by end-fiscal year 2019, from 71.7 percent a year earlier. The substantial rise in the debt ratio reflects the impact of rupee depreciation on external debt and the wider fiscal deficit. The government was highly reliant on direct borrowing from the SBP, as domestic banks lacked the appetite for government debt in the context of rapidly rising interest rates.

The debt-to-GDP ratio will remain high at 77 percent by the end of the fiscal year 2020. The accumulation of losses in public-sector enterprises, particularly the energy sector’s ‘circular debt’ (inter-company arrears) of about 3 percent of GDP, poses a contingent liability for the government.

GDP growth slowed sharply to 3.3 percent in the fiscal year 2019 from 5.5 percent in the fiscal year 2018 on the back of declines in the manufacturing and agricultural sectors, according to the government’s preliminary estimates. Fitch forecasts growth to rise slightly to 3.5 percent in the fiscal year 2020, although it will be constrained by fiscal consolidation and tighter monetary policy.

Fitch estimates inflation rose sharply to 7.2 percent in the fiscal year 2019 from 3.9 percent in the fiscal year 2018, largely as a result of rupee depreciation. The impact of the SBP’s rate hikes on overall monetary conditions was weakened by the monetization of government debt through the government’s direct borrowing from the SBP.

Fitch projected government borrowing from the SBP to cease as part of the IMF program. Inflation is set to remain high at 9 percent on the back of past rupee depreciation and tax and energy tariff increases.

Domestic security has improved over the past couple of years, measured by a decline in terrorist incidents and casualties. Nevertheless, ongoing domestic threats and geopolitical tensions with neighboring countries continue to weigh on investor sentiment.

Pakistan’s rating is constrained by structural weaknesses in its development and governance indicators. Its per capita GDP of $1,566 is well below the $3,489 median of ‘B’ rated peers. Governance quality is also low as its World Bank governance indicator score is in the 23rd percentile, compared with the ‘B’ median’s 38th percentile.

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