The Standard & Poor’s (S&P) Global Ratings has affirmed its ‘B-‘ long-term and ‘B’ short-term sovereign credit ratings on Pakistan.
The outlook for the long-term rating is stable. The New York-based rating agency has also affirmed ‘B-‘ long-term issue rating on Pakistan’s senior unsecured debt and Sukuk trust certificates.
The ratings on Pakistan reflect the fallout of the COVID-19 pandemic on the country’s already weak economy, considerable external indebtedness and liquidity needs, and an elevated general government fiscal deficit and debt stock.
While Pakistan had made progress toward consolidating its fiscal accounts during the first nine months of its Extended Funding Facility (EFF) program with the IMF, related imbalances have been worsened by much slower economic growth since March 2020, said the agency.
COVID-19 is exacerbating the weakness in Pakistan’s economy, which has slowed markedly since 2017.
Pakistan’s economic growth trend has fallen below that of its international peers’. Reform initiatives have improved since the introduction of IMF’s EFF program in 2019, but progress is likely to be delayed amid the pandemic.
The pandemic has worsened Pakistan’s deep economic downturn.
Prior to the onset of the pandemic, Pakistan was making important headway toward implementing economic and fiscal reforms under its EFF program with the IMF. As of end-December 2019, the government had met all performance criteria and completed all structural benchmarks of the IMF program, it said.
S&P stated that Pakistan had made strong progress toward containing its twin current account and primary fiscal deficits, and had begun to rebuild its foreign exchange reserves alongside a more flexible rupee exchange rate regime.
In particular, domestic demand in the economy remains very weak, as evident from contractions in both real consumption and imports in the fiscal year ended in June 2020. Prospects for a near-term recovery have dimmed following strict domestic virus containment measures implemented between March and June, and in the face of a much weaker global economic outlook.
The pandemic will challenge further progress in some of these areas, especially fiscal consolidation and reserve accumulation. Despite having stabilized in the first three quarters of the fiscal year, a deep downturn in the April-June period led the Pakistani economy to a full-year contraction of nearly 0.4% in fiscal 2020.
Renewed weakness in the economy will undermine revenue generation while complicating the government’s efforts to curtail expenditure. The government is likely to focus on implementing last year’s new revenue measures in the current fiscal period, rather than to introduce additional policies against a backdrop of poor business and consumer sentiment.
The ratings on Pakistan remain constrained by a narrow tax base and domestic and external security risks, which continue to be high. Although the country’s security situation has gradually improved over the recent years, ongoing vulnerabilities weaken the government’s effectiveness and weigh on the business climate.
Pakistan’s economy is likely to recover only gradually as the global pandemic is progressively better contained. Following Pakistan’s worst economic performance on record in fiscal 2020, the rating agency forecasts a modest expansion of 1.3% in fiscal 2021.
Taken together with its relatively fast population growth of approximately 2.0% per year, real per capita economic growth will likely remain negative for a third straight year, at -0.7%. That will contribute to a further decline in Pakistan’s 10-year weighted average per capita growth rate to just 0.6%, well below the global median of 1.5% for economies at a similar level of income, it added.
The agency forecasts that GDP per capita to remain just above US$1,200 by the end of this fiscal year, versus closer to US$1,600 in fiscal 2018.
Growth will also be constrained by domestic security challenges and extended hostility with neighboring India and Afghanistan. The former Pakistan Muslim League government improved the security situation within the country, and they expect the government to continue this positive momentum.
However, tensions with neighboring India flared on multiple occasions in 2019, and further incidents, especially in the vicinity of the line of control in Kashmir, cannot be ruled out, it added.
S&P believes the government’s adoption of reforms under the IMF program has been constructive in addressing accumulated economic and external balances, the economy is likely to face further stress until the pandemic is meaningfully contained and global conditions materially improved.
Pakistan’s external metrics have stabilized in line with a much smaller current account deficit in 2020. The government still faces considerable external liabilities, including commercial bank loans.
The country’s fiscal and debt positions will deteriorate further owing to the pandemic-induced economic downturn.
Despite the ongoing implementation of reforms, the Pakistan government continues to face substantial pressure on its finances. After an estimated general government fiscal deficit of 8.1% of GDP in fiscal 2020, it forecasts an elevated shortfall equivalent to 8.5% of GDP this year, largely owing to revenue constraints amid the weak economy.
Heading into 2020, the government had begun to implement difficult reform measures, with an emphasis on revenue generation. These measures appeared to be leading toward a more sustainable fiscal trajectory for the government, with the primary balance shifting into surplus prior to the onset of the pandemic.
Under the auspices of the IMF EFF program, the government has shown a strong willingness to consolidate its fiscal position, and we believe it would have achieved lower annual fiscal deficits and a greater revenue share of GDP in the absence of the exogenous shock of the pandemic.
However, Pakistan’s ratio of tax revenue to GDP remains one of the lowest among sovereigns, and they believe material improvements will be delayed by Pakistan’s weak economic outlook.
In their view, it is difficult to increase revenue as a share of GDP during a period of muted economic growth; we therefore expect the government’s revenue-to-GDP ratio to retreat slightly to 12.5% this fiscal
l year, before recovering to more than 13% from fiscal 2022. They see the average annual change in net general government debt at 6.9% of GDP through 2023, reflecting our expectations for a high deficit this year, followed by gradually smaller shortfalls.
Coupled with the economy’s weak growth outlook, continued high fiscal deficits will push Pakistan’s net general government debt to a multi-decade high of 84.5% of GDP this fiscal year
The stable outlook reflects S&P’s expectations that donor and partner financing will ensure that Pakistan can meet its external obligations over the next 12 months and that the country will continue to roll over its commercial credit lines.
The agency may lower the ratings if Pakistan’s fiscal, economic, or external indicators deteriorate further, such that the government’s external debt repayments come under pressure. Indications of this would include external or fiscal imbalances higher than what we expect.
Conversely, S&P Global may raise their ratings on Pakistan if the economy materially outperforms our expectations, strengthening the country’s fiscal and external positions more quickly than forecast.