June 3, 2022
ISLAMABAD – Moody’s Investor Service on Thursday downgraded Pakistan’s outlook from stable to negative, citing “heightened external vulnerability” and uncertainty around securing external financing to meet the country’s needs.
“The decision to change the outlook to negative is driven by Pakistan’s heightened external vulnerability risk and uncertainty around the sovereign’s ability to secure additional external financing to meet its needs. Moody’s assesses that Pakistan’s external vulnerability risk has been amplified by rising inflation, which puts downward pressure on the current account, the currency and — already thin — foreign exchange reserves, especially in the context of heightened political and social risk,” the statement said.
It added that the country’s “weak institutions and governance strength” had added uncertainty around the future direction of macroeconomic policy, including whether Pakistan would complete the International Monetary Fund’s (IMF) Extended Fund Facility (EFF) programme and maintain a credible policy path that supports further financing.
However, Moody’s affirmed Pakistan’s B3 local and foreign currency issuer and senior unsecured debt ratings as well as the (P)B3 senior unsecured medium-term note (MTN) programme rating. MTN allows continuous or intermittent fundraising from investors through the designated or appointed dealers.
Explaining the decision to affirm the B3 rating, Moody’s said it assumed that Pakistan would conclude its seventh review under the IMF EFF programme by the second half of this calendar year and would maintain its engagement with the Fund, leading to additional financing from other bilateral and multilateral partners.
“Moody’s assesses that Pakistan will be able to close its financing gap for the next couple of years. The B3 rating also incorporates Moody’s assessment of the scale of Pakistan’s economy and robust growth potential, which will provide the economy with some capacity to absorb shocks.
“These credit strengths are balanced against Pakistan’s fragile external payments position, weak governance and very weak fiscal strength, including very weak debt affordability,” the statement said.
Moody’s said that the B3 rating affirmation also applied to the backed foreign currency senior unsecured ratings for The Third Pakistan International Sukuk Co Ltd and The Pakistan Global Sukuk Programme Co Ltd.
However, it added that the ceilings for the local and foreign currency country ceilings were lowered to B1 and B3, from Ba3 and B2, respectively.
“The two-notch gap between the local currency ceiling and sovereign rating is driven by the government’s relatively large footprint in the economy, weak institutions, and relatively high political and external vulnerability risk.
“The two-notch gap between the foreign currency ceiling and the local currency ceiling reflects incomplete capital account convertibility and relatively weak policy effectiveness, which point to material transfer and convertibility risks notwithstanding moderate external debt,” the statement said.
Heightened external vulnerability risk
Further explaining its reasons for the downgrade, Moody’s said it expected the current account to remain under “significant pressure” due to elevated global commodity prices through 2022 and 2023.
“Pakistan’s current account deficit (CAD) has widened to a cumulative $13.8 billion since the start of the current fiscal year in July 2021 up until April 2022, compared to a deficit of $543 million in the same period a year earlier. In the absence of an equivalent inflow in the financial account, the rapid widening of the current account deficit has led to a large drawdown of the foreign exchange reserves,” it said.
The statement added that the country’s foreign exchange reserves have declined to $9.7bn at the end of April, sufficient to cover only “less than two months of imports”.
Moody’s projected the CAD to come in at 4.5-5 per cent of the GDP for the current fiscal year, slightly wider than the government’s expectations. “As global commodity prices decline gradually in 2023 and as domestic demand moderates, Moody’s expects the current account deficit to narrow to 3.5-4pc of GDP,” the statement added.
“The larger CADs underscore the need for Pakistan to secure additional external financing, especially given its very low foreign exchange reserves.”
Moody’s said that while it was hopeful Pakistan would complete its IMF review and attract further external financing, if Pakistan failed to do so then it could face a balance of payments crisis.
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Heightened political risk
Commenting on the country’s political outlook, Moody’s said: “Political uncertainty in Pakistan remains high, even after the new government has been installed. The new ruling coalition comprises of multiple political parties with divergent interests, which is likely to make the enactment of any legislation difficult, including those related to reforms under the IMF EFF programme.”
It added that with the elections due by next years, political parties would find it difficult to to continually enact significant revenue-raising measures in the run-up to the elections.
“Rising interest rates are also likely to increasingly constrain the government’s policy choices, especially since interest payments already absorb more than 40pc of revenue.”
Moody’s also outlined terrorism as a serious concern for the country, saying that a higher frequency of terrorist attacks was observed over the past year.
Read more: Growing security concerns
“More frequent terrorist attacks add to safety concerns, which may increase social risks, as well as constrain business conditions and limit investment.
“Moody’s assesses that there is a material probability of a recurrence in domestic political stress that will impinge on the effectiveness of policymaking and the government’s ability to implement timely economic reforms aimed at achieving macroeconomic stability,” the statement said.
‘Capacity to absorb economic shocks’
Further elaborating on its decision to maintain the B3 rating, Moody’s said that Pakistan’s large size and robust potential growth provided it with some capacity to absorb economic shocks.
“Pakistan’s potential growth of about 5pc in part reflects the country’s favourable demographics with its sizeable under-30 population. Nonetheless, Pakistan’s potential growth is constrained by structural challenges, including weak governance and weak competitiveness.”
The statement pointed out that the country was “vulnerable” to environmental risks, pointing to the significant usage of “scarce fresh water resources” every year and extreme weather events.
Moody’s said it projected real GDP growth to slown down to 4.2pc in the next fiscal year from 6pc for the current fiscal year. “The moderation in economic activity reflects the drag on domestic demand from rising inflation and a tightening in monetary policy by the State Bank of Pakistan,” it said, adding, however, that it expected the real GDP to pick up gradually and reach 4.5-5pc over fiscal years 2024 and 2025.
On Pakistan’s fiscal strength, Moody’s said it was “very weak” and expected fiscal consolidation to stall ahead of the next general elections.
Pakistan Initiative at Atlantic Council’s South Asia Centre Director Uzair Younus said there “nothing surprising” about Moody’s decision as he criticised the government’s “dilly-dallying” in getting the IMF programme back on track.
“With a subsidy still in place for petroleum products, it’s unlikely IMF will convey any positive news to Pakistan any time soon,” he pointed out.
Analyst Mosharraf Zaidi said the blame for the rating downgrade was on the current government.
“No one asked PML-N to refuse to raise prices [of petroleum products] for six weeks. Raise the prices on day one and this rating downgrade would not have happened,” he said.
Meanwhile, the PTI criticised the current government, saying that “each day of this imported government is causing immense damage to our country.”
“As expected this comes as another huge blow to our economy,” remarked PTI Senator Faisal Javed.