Fitch Ratings Upgrades Pakistan’s Outlook to CCC+

FitchRatings has upgraded Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CCC+’ from ‘CCC’.

The upgrade reflects greater certainty over the continued availability of external funding, in the context of Pakistan’s staff-level agreement (SLA) with the IMF on a new 37-month $7 billion Extended Fund Facility (EFF). Strong performance on the previous, more temporary IMF arrangement helped the country narrow fiscal deficits and rebuild foreign exchange (FX) reserves, and further improvements are likely.

Nevertheless, Pakistan’s large funding needs leave it vulnerable if it fails to implement challenging reforms, which could undermine program performance and funding.

New IMF Programm

Pakistan and the IMF reached the SLA on 12 July. Before IMF Board approval, which the agency assumed by end-August, the government will have to obtain new funding assurances from bilateral partners, chiefly Saudi Arabia, the UAE and China, totalling about USD4 billion-5 billion over the duration of the EFF. “We believe this will be achievable, given the strong past record of support and significant policy measures in the recent budget for the fiscal year ending June 2025 (FY25),” it added.

Ambitious Reforms

The government aims under the new EFF to tackle longstanding structural weaknesses in Pakistan’s tax system, energy sector and state-owned enterprises, alongside a commitment to exchange rate flexibility and improvements in the monetary policy framework. It targets a 3pp increase in tax revenues/GDP, from under 9% in FY24, including through higher taxes on the country’s influential agricultural sector, which will have to be legislated at the provincial level.

Strong Recent Policy Record

Pakistan completed its nine-month Stand-by Arrangement with the IMF in April. Over the past year, the government raised taxes, cut spending and raised electricity, gas and petrol prices. The government also all but eliminated the gap between the interbank and parallel market exchange rates through a crackdown on the black market and regulation of exchange houses.

Narrower External Deficit

The agency forecast the current account deficit (CAD) to stay relatively contained at about USD4 billion (about 1% of GDP) in FY25, after about USD700 million in FY24, given tight financing conditions and subdued domestic demand. Contractionary economic and fiscal policies, lower commodity prices and rupee depreciation have driven the sharp narrowing of the CAD from over USD17 billion in FY22. FX shortages have eased with the return of remittances to the official banking system, reversing their decline in 2H22.

Funding Needs Still Large

Besides CADs, the authorities face over USD22 billion in external public debt maturities in FY25. Of the total maturities, USD13 billion is in the form of bilateral deposits and loans that are regularly rolled over, including nearly USD4 billion in liabilities of the State Bank of Pakistan (SBP). Maturing debt also includes nearly USD4 billion from Chinese commercial banks, and USD4 billion from multilateral creditors. Pakistan’s next international bond maturity is in September 2025.

The government says it has identified over USD24 billion in gross external financing, mostly from bilateral and multilateral sources, not including potential bond issuance or the renewal of the oil facility with Saudi Arabia, but including a potential Panda bond issuance. FDI and non-resident portfolio inflows and climate-related finance pose other upsides to the funding plan.

Reserves Have Recovered; Still Low

The SBP is rebuilding FX reserves amid inflows of new funding and limited CADs. Fitch Ratings estimated official gross reserves, including gold, rose to over USD15 billion at June 2024 (about three months of imports), from nearly USD10 billion at end-June 2023, and expects them to rise to nearly USD22 billion by FYE26, close their 2021 peak.

The SBP’s narrower measure of net liquid FX reserves (excluding gold and FX reserve deposits of banks) recovered to over USD9 billion at June 2024. The SBP has reduced its forward liabilities to local banks and is approaching a balanced net foreign asset/liability position.

Fiscal Consolidation

Half of the revenue effort under the EFF is frontloaded in the FY25 budget, which was prepared together with IMF staff and projects a headline deficit of 5.9% of GDP and a 2.0% primary surplus (FY24 estimate: 7.4% and 0.4%, respectively). Fitch Ratings’ forecasts assume partial implementation of this and project a primary surplus of 0.8% of GDP and an overall fiscal deficit of 6.9% of GDP in FY25, improving to 1.3% of GDP and 6% of GDP, respectively, in FY26.

Besides tax measures, the budget assumes a doubling of SBP dividends to 2% of GDP, and a doubling of provincial surpluses to 1% of GDP.

The ‘CCC+ Long-Term Foreign-Currency IDR also reflects the following factors:

Challenging Politics

“The close outcome of the February elections delivered a weaker-than-expected mandate for Prime Minister Shehbaz Sharif’s PMLN party. PMLN and its allies command only a slim majority in the National Assembly after a recent Supreme Court ruling re-allocating reserved seats in favor of independents linked with former prime minister Imran Khan’s PTI party. Mr Khan has been in prison since May 2023, but remains popular,” the agency said.

Implementation Risks

Before the recent SBA, governments from across the political spectrum in Pakistan have had a mixed record of IMF program performance, often failing to implement or reverse the required reforms. The current apparent consensus within Pakistan on the need for reform could weaken once economic and external conditions improve, although Pakistan now has fewer financing options than in the past.

High, Stable Debt Level

The agency estimated government debt fell to 68% of GDP by FYE24, from 75% at FYE23, due to high inflation and deflator effects, offsetting soaring domestic interest costs. This is broadly in line with the B/C/D median. The agency expects inflation and interest costs to decline in tandem, with economic growth and primary surpluses driving government debt/GDP gradually lower.

Debt/revenue (over 500% in FY24) and interest/revenue (over 60%) ratios are far worse than those of peers, largely due to very low revenue/GDP, although high interest rates also benefit tax revenue and SBP profits.

ESG – Governance

Pakistan has an ESG Relevance Score (RS) of ‘5’ for both political stability and rights and for the rule of law, institutional and regulatory quality and control of corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in the agency’s proprietary Sovereign Rating Model (SRM). Pakistan has a WBGI ranking at the 22nd percentile.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

• Public Finances: Renewed deterioration in external liquidity conditions that could result from delays in IMF program reviews or indications that the authorities are considering debt restructuring.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

• External Finances: Sustained recovery in foreign-currency reserves and further significant easing of external financing risks
• Public Finances: Implementation of fiscal consolidation plans in line with IMF program commitments, leading to increased confidence in a downward trajectory for government debt.