Moody’s Investors Service, (“Moody’s”) has today placed the Government of Pakistan’s local and foreign currency long-term issuer and senior unsecured B3 ratings under review for downgrade.
The decision to place the ratings under review for downgrade reflects Moody’s expectation that the government will request for bilateral official sector debt service relief under the recently announced G20 initiative.
Suspension of debt service obligations to official creditors is unlikely to have rating implications; indeed such relief will increase the fiscal resources available to the government for essential health and social spending due to the coronavirus outbreak, noted the credit rating agency.
However, the G20 has called on private sector creditors to participate in the initiative on comparable terms.
Consistent with Moody’s approach globally, the review period will allow the rating agency to assess whether Pakistan’s participation in the initiative will likely entail default on private sector debt, notwithstanding the intended voluntary nature of private sector participation and the fact that the country has not, to Moody’s knowledge, indicated an interest in extending the debt service relief request to the private sector; and, if so, whether any losses are expected to arise from that participation will be consistent with a lower rating.
The rapid spread of the coronavirus, sharp deterioration in the global economic outlook, and a significant reduction in risk appetite are creating a severe economic and financial shock, maintained Moody’s.
For Pakistan, the current shock transmits mainly through a sharp slowdown in economic activity, lower tax revenue as economic activity slows, and higher government financing needs relative to pre-coronavirus levels.
However, ongoing reforms that pointed to a nascent improvement in credit fundamentals before the outbreak and financing from development partners contain the pressure on the sovereign’s liquidity and external positions.
Concurrently, Moody’s has also placed the B3 foreign currency senior unsecured ratings for The Third Pakistan International Sukuk Co Ltd under review for downgrade. The associated payment obligations are, in Moody’s 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.
The driver for the review for downgrade is Moody’s expectation that Pakistan will request bilateral debt service relief from G20 creditors under the recently announced initiative and the associated possibility of losses to private-sector creditors.
The initiative offers benefits for the world’s poorest nations, many of which have large external payment obligations and are exposed to outflows of capital and depreciating exchange rates during this unprecedented shock. Additional financial support and liquidity relief will allow fiscal resources to be devoted to essential health efforts and towards minimizing the economic and social impact of the outbreak.
However, the G20 has called on private sector creditors to participate in the initiative on comparable terms. This suggests that, for the countries that elect to seek official sector debt service relief, the initiative may also lead to the suspension of payments or renegotiation of private-sector debt service obligations. It is in this context that Moody’s has placed Pakistan’s ratings under review, in line with the rating agency’s approach globally.
During the review period, Moody’s will assess whether Pakistan’s participation in the initiative will indeed be implemented without private sector participation, consistent with the intended voluntary nature of private sector participation, or whether any losses may be expected to arise for private-sector creditors that will be consistent with a lower rating. Pakistan has not indicated any interest in extending the debt service relief to include private-sector creditors.
At this stage, Moody’s assesses that the main impact of the coronavirus shock is on Pakistan’s economic growth, which raises fiscal challenges and delays the government’s fiscal consolidation and debt reduction efforts.
Ongoing and significant financial and technical support from development partners, as well as the effective use of monetary policy, mitigate the impact of the shock on the sovereign’s liquidity and external positions.
The Pakistani economy is relatively closed, with low reliance on exports and private capital inflows and limited trade linkages. However, the coronavirus outbreak presents a significant shock to the domestic economy in part due to the measures aimed at restricting the movement of people to prevent the spread of the virus, maintained Moody’s.
Environmental, social and governance considerations
Moody’s stated that environmental considerations are significant to Pakistan’s credit profile because it is vulnerable to climate change risk. Pakistan is significantly exposed to extreme weather events, including tropical cyclones, drought, floods and extreme temperatures.
“In particular, the magnitude and dispersion of seasonal monsoon rainfall influence agricultural sector growth and rural household consumption. The agricultural sector directly accounts for around 20% of GDP and exports, and nearly 40% of total employment. As a result, both droughts and floods can create economic, fiscal and social costs for the sovereign,” said the credit rating agency.
Social considerations are material to Pakistan’s credit profile. Access to quality healthcare, education and utilities such as electricity and water remains limited, especially in rural areas, although the government is addressing these issues as a key priority through its “Ehsaas” program that is aimed at reducing poverty and inequality, strengthening social safety nets and promoting human capital development, noted Moody’s.
Moody’s regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.
“For Pakistan, the epidemic exposes the challenge to the government in enhancing healthcare and public services provision,” said the agency.
Governance considerations are significant to Pakistan’s credit profile, added the credit rating agency.
International surveys of various indicators of governance, while showing some early signs of improvement, point to weak rule of law and control of corruption, as well as limited government effectiveness.
These weaknesses are balanced against a lengthening track record of effective checks and balances and judicial independence for the level of development in the country, maintained Moody’s.
What could lead to a confirmation of the rating at the current level
The rating will likely be confirmed at its current level should Moody’s conclude that participation in bilateral official sector debt service relief would unlikely entail default on private sector debt or, if it would, that any losses experienced would likely be minimal.
Upon conclusion of the review, and under a scenario of no or minimal loss for private-sector creditors, expectations that government financing, debt sustainability, and external vulnerability risks are contained would likely be consistent with a stable outlook at B3, said Moody’s.
What could change the rating down?
The rating would likely be downgraded should Moody’s conclude that participation in the G20 debt service relief initiative would probably entail default on private sector debt and that losses experienced would likely exceed the threshold consistent with a B3 rating.
Downward pressure on the rating would also stem from a renewed and material deterioration in Pakistan’s external position, including through a significant widening of the current account deficit and erosion of foreign exchange reserve buffers, which would threaten the government’s external repayment capacity and heighten liquidity risks.
A continued rise in the government’s debt burden, without prospects for stabilization over the medium term, would additionally put downward pressure on the rating, noted Moody’s.
On 11 May 2020, a rating committee was called to discuss the rating of Pakistan.
The main points raised during the discussion were:
- The issuer’s economic fundamentals, including its economic strength, have not materially changed.
- The issuer’s institutions and governance strength, have not materially changed.
- The issuer’s fiscal or financial strength, including its debt profile, has not materially changed.
- The issuer’s susceptibility to event risks has not materially changed.