February 15, 2023
ISLAMABAD – Global rating agency Fitch on Tuesday downgraded Pakistan’s long-term foreign currency issuer default rating (IDR) to ‘CCC-’ from ‘CCC+’, citing further worsening in liquidity and policy risks along with pressure on foreign exchange reserves.
The drop comes four months after Fitch revised down the ranking to CCC+.
The agency did not assign any outlook since typically it does not assign outlooks to sovereigns with a rating of ‘CCC+’ or below.
Fitch said that the downgrade reflected a further sharp deterioration in external liquidity and funding conditions, along with the decline of foreign exchange (FX) reserves to “critically low levels”.
“While we assume a successful conclusion of the ninth review of Pakistan’s IMF (International Monetary Fund) programme, the downgrade also reflects large risks to continued programme performance and funding, including in the run-up to this year’s elections. Default or debt restructuring is an increasingly real possibility, in our view,” said the New York-based agency — one of the three major global rating agencies.
The agency said that FX reserves were only about $2.9 billion on February 3, or less than three weeks of imports, noting that it was down from a peak of more than $20bn at the end of August 2021.
“Falling reserves reflect large, albeit declining, current account deficits (CADs), external debt servicing and earlier FX intervention by the central bank, particularly in 4Q22, when an informal exchange-rate cap appears to have been in place.
“We expect reserves to remain at low levels, though we do forecast a modest recovery during the remainder of FY23, due to anticipated inflows and the recent removal of the exchange rate cap,” the agency said.
It said another factor for the rating downgrade was the large refinancing risk with external public debt maturities in the remaining fiscal year amounting to over $7bn, adding that they would remain high in the next fiscal year as well.
The agency also noted that although the CAD was declining, it could widen again.
“The narrowing of the CAD has been driven by restrictions on imports and FX availability, as well as by fiscal tightening, higher interest rates and measures to limit energy consumption.
“Reported backlogs of unpaid imports in Pakistan’s ports indicate that the CAD could increase once more funding becomes available. Nevertheless, exchange-rate depreciation could limit the rise, as the authorities intend for imports to be financed through banks, without recourse to official reserves. Remittance inflows could also recover after they were partly switched to unofficial channels in 4Q22 to benefit from more favourable exchange rates in the parallel market,” the agency explained.
Fitch also highlighted difficult IMF conditions, a challenging political context and funding contingent on the IMF programme as other factors for the rating downgrade.
“Shortfalls in revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate have held up the ninth review of Pakistan’s IMF programme, which was originally due in November 2022. We understand that completion of the review hinges on additional front-loaded revenue measures and increases to regulated electricity and fuel prices.
“The IMF’s conditions are likely to prove socially and politically difficult amid a sharp economic slowdown, high inflation and the devastation wrought by widespread floods last year. Elections are due by October 2023, and former prime minister Imran Khan, whose party will challenge the incumbent government in the elections, earlier rejected an invitation by Prime Minister Shehbaz Sharif to hold talks on national issues, including IMF negotiations.
“Recent funding stress has been marked by the apparent reluctance of traditional allies — China, Saudi Arabia and the United Arab Emirates — to provide fresh assistance in the absence of an IMF programme, which is also critical for other multilateral and bilateral funding,” the agency said.
The agency further explained that the IDR reflected certain other factors such as the renewed commitment by the authorities to the IMF and taking actions that will facilitate the agreement with the Fund.
“This includes an apparent removal of a cap on the rupee exchange rate in January. The prime minister has repeatedly expressed the intention to remain in the programme,” the press release added.
Furthermore, Fitch said that Pakistan stood to receive additional funding in the pipeline apart from the remaining $2.5bn IMF disbursements.
“Pakistan stands to receive $3.5bn from other multilaterals in FY23 after agreement with the IMF is reached. There have been reports of over $5bn in additional commitments being considered by allies, on top of rollovers of existing funding, although details on the size and conditions are still pending. Pakistan received $10bn in pledges at a flood-relief conference in January 2023, mostly in the form of loans.”
Fitch also noted that the government remained committed to servicing its debts, having repaid a sukuk due in December 2022 with the next scheduled bond maturity not until April 2024.
Despite this, Fitch noted that debt restructuring could not be fully excluded as a possibility.
“The previous finance minister said before resigning that Pakistan would seek debt relief from non-commercial creditors.
“In addition, the prime minister had appealed for bilateral debt relief within the Paris Club framework, although no official request has been sent and this is no longer under consideration according to the authorities. Should Paris Club debt treatment be sought, Paris Club creditors would be likely to require comparable treatment for private external creditors in any restructuring. We believe local debt might be included in any restructuring, despite macro-financial stability considerations, as it accounts for 90 per cent of the government’s interest burden,” the agency elaborated.
Further rating changes
On what could lead to a further rating downgrade, Fitch said signs of a possible default could be reasons such as “indications that the authorities are considering debt restructuring or further deterioration in external liquidity and funding conditions making traditional payment default more likely”.
On the other hand, it said that “strong performance” against IMF programme conditions, ensuring the continued availability of funding, rebuilding of foreign-currency reserves and easing of external financing risks could lead to a positive rating upgrade.