Fitch Ratings on Friday downgraded Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CCC+’ from ‘B-‘. Fitch typically does not assign Outlooks to sovereigns with a rating of ‘CCC+’ or below.
In a statement, Fitch said it typically does not assign Outlooks to sovereigns with a rating of ‘CCC+’ or below.
The agency said that the downgrade reflects further deterioration in Pakistan’s external liquidity and funding conditions, and the decline of foreign-exchange (FX) reserves. This is partly a result of widespread floods, which will undermine Pakistan’s efforts to rein in twin fiscal and current account deficits. The downgrade also reflects our view of increased risks of policies potentially undermining Pakistan’s IMF programme and official financial support.
It mentioned that liquid net FX reserves of the State Bank of Pakistan (SBP) were about $7.6 billion by 14 October 2022, or about a month of current external payments, down from more than $20 billion at end-August 2021.
“Falling reserves reflect large, albeit, declining current account deficits (CADs), external debt servicing and earlier FX interventions by the SBP,” the agency said.
It mentioned that before stabilising in the week to 14 October, reserves had been falling every week since the disbursement of $1.2 billion from the IMF in the week to 2 September, upon the completion of the 7th and 8th reviews of Pakistan’s Extended Fund Facility (EFF).
On external deficits, the agency mentioned that current account deficit (CAD) reached $17 billion (4.6 percent of GDP) in the fiscal year to June 2022 (FY22), driven by soaring oil prices and higher non-oil imports on strong private consumption.
Fiscal tightening, higher interest rates and measures to limit energy consumption and imports underpin our forecast for the CAD to narrow to $10 billion (2.7 percent of GDP) in FY23, despite the hit to export revenue and import needs after the recent floods. Lower imports and commodity prices helped to narrow the CAD in recent months, to about $300 million in September.
Large Funding Needs
Pakistan’s external public debt maturities in FY23 are over $21 billion, mostly to bilateral and multilateral creditors, which mitigates rollover risks, and there are already agreements to roll over some of these. The authorities estimate the flood damage at $10 billion-30 billion, but reconstruction costs are likely to be lower, as is the impact on Pakistan’s twin deficits.
Pakistan recently received funding commitments of $2.5 billion from the World Bank and Asian Development Bank, according to the authorities, although we understand that much of this is repurposed from ongoing programmes. It remains unclear to what degree the IMF will be able to relax Pakistan’s programme targets, or augment Pakistan’s access under the EFF.
Policy, IMF Programme Risks
We assume Pakistan will continue to receive disbursements under its IMF programme, but risks to this have risen. Fuel-price cuts from 1 October may not be compatible with commitments to the IMF. A quarterly electricity tariff adjustment due in October has yet to happen. The new finance minister has re-affirmed commitment to the programme, but prefers a strong exchange rate, and may revisit the SBP law that was amended in early 2022 to grant the SBP greater autonomy, as previously agreed with the IMF.
The agency said that the ‘CCC+’ Long-Term Foreign-Currency IDR also reflects the following factors:
Debt Relief Raised, Rejected
The previous finance minister said before resigning that Pakistan would seek debt relief from non-commercial creditors, although he reiterated the intention to repay the $1 billion bond due in December 2022. Prime Minister Shehbaz Sharif also appealed for debt relief within the Paris Club framework. More recently, however, the Minister of Finance publicly ruled this out.
Pakistan’s debt to private creditors (or official Paris Club creditors) is only a small fraction of the total and the authorities maintain that they have no intention to restructure debt to private creditors.
Former Prime Minister Imran Khan, who was ousted in a no-confidence vote on 10 April, continues to put political pressure on the government, organising protests across the country calling for early elections. Mr Khan’s PTI party won by-elections in the key Punjab province in July, defeating the incumbent PML-N, and PTI won more national and provincial seats in by-elections on 17 October. Regular elections are due in October 2023, creating the risk of policy slippage after the conclusion of the IMF programme due in June.
Fiscal Worsening, Consolidation
The fiscal deficit widened to 7.9 percent of GDP (over Rs. 5 trillion) in FY22, from 6.1 percent in FY21. Tax reductions and subsidies on fuel and electricity account for most of the fiscal deterioration; these were introduced by the previous government in February and lasted until June. We expect a narrowing of the deficit to 6.2 percent of GDP (about Rs. 5 trillion or $23 billion) in FY23, driven by some spending restraint and higher taxes.
Debt to Decline
Pakistan’s debt/GDP ratio was 73 percent at FYE22, broadly in line with the current ‘B’ median. We expect debt/GDP to fall to 70 percent in FY23 and continue decreasing, helped by high inflation and a modest primary deficit. A low FX exposure at just over 30 percent of total debt limits the negative impact of currency depreciation on debt dynamics. Nevertheless, debt/revenue (at over 600 percent in FY22) and interest/revenue (at about 40 percent) are significantly worse than the ‘B’ median. This largely reflects low general government revenue of 12 percent of GDP in FY22.
High Inflation, Monetary Tightening
Consumer price inflation averaged 12.2 percent in FY22 but accelerated to 21.3 percent YoY in June and averaged 25 percent YoY in July-September, driven by hikes to petrol and electricity prices. The SBP maintained its policy rate at 15 percent at its last meeting on 10 October, after cumulative rate hikes of 800bps in the latest tightening cycle.
We forecast GDP growth to decelerate to about 2 percent in FY23, from 6 percent in FY22, amid fiscal and monetary tightening, high imported inflation, a weak external demand outlook, and flood-related disruptions. This is broadly in line with the government’s forecast, down from its initial target of 5 percent and a 3.5 percent forecast in the IMF programme. The 2010-2011 floods contributed to Pakistan’s weak recovery after the global financial crisis.