Fitch downgrades Pakistan’s sovereign rating to CCC-

KARACHI: Fitch on Tuesday downgraded Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CCC-’, from ‘CCC+’ on account of sharp deterioration in external liquidity and funding conditions, and the decline of foreign-exchange reserves to critically low levels.

No outlook was assigned to the country, in line with its policy of not assigning outlooks to ratings of ‘CCC+’ or below.

The agency’s rating action commentary, said, “While we assume a successful conclusion of the 9th Review of Pakistan’s IMF 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.”

Pointing to Pakistan’s low reserves, it said that the liquid foreign exchange reserves of the State Bank of Pakistan (SBP) were at $2.9 billion on February 3, 2023, which would cover less than three weeks of imports. The reserves are down from a peak of more than $20 billion at the end of August 2021.

“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.

Commenting on the large refinancing risks, it said external public-debt maturities in the remainder of the fiscal year ending June 2023 (FY23) amount to over $7 billion and would remain high in FY24. Of the $7 billion remaining for FY23, $3 billion represent deposits from China (SAFE) that are likely to be rolled over, and $1.7 billion are loans from Chinese commercial banks, which “we also assume will be refinanced in the near future”.

The SAFE deposits would mature in two instalments: $2 billion in March and $1 billion in June, it added.

Although, Pakistan’s current account deficit was declining, it could widen again. Pakistan’s current account deficit was $3.7 billion in 2H22, down from $9 billion in 2H21. Fitch forecast a full-year deficit of $4.7 billion (1.5 percent of GDP) in FY23 after $17 billion (4.6 percent of GDP) in FY22. This was mostly driven by restrictions on imports and forex availability, as well as by fiscal tightening, higher interest rates and measures to limit energy consumption.

However, the ratings agency commented that the once more funding was unlocked, the current account deficit could increase again as indicated by the backlogs of unpaid imports stranded at Pakistan’s ports.

“Nevertheless, exchange-rate depreciation could limit the rise, as the authorities intend for imports to be financed through banks, without recourse to official reserves,” it said.

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, it said.

Pointing to the difficult IMF conditions, the ratings agency said that shortfalls in revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate have held up the 9th 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,” Fitch said, adding that the IMF’s conditions were likely to prove socially and politically difficult amid a sharp economic slowdown, high inflation, and the devastation wrought by widespread floods last year.

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 was also critical for other multilateral and bilateral funding.

However, the authorities appear close to agreement on the 9th programme review after the conclusion of the IMF’s staff visit to Pakistan on February 9, and have already taken action that should facilitate agreement. 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.

Apart from the remaining $2.5 billion IMF disbursements, Pakistan also has other funding in the pipeline, including $3.5 billion from other multilaterals in FY23. However, those would be unblocked after an agreement with the IMF was reached.

There have been reports of over $5 billion in additional commitments being considered by allies, on top of rollovers of existing funding, although details on the size and conditions were still pending. Pakistan received $10 billion in pledges at a flood-relief conference in January 2023, mostly in the form of loans.

Pakistan’s government remains committed to debt servicing, and the prime minister has also expressed the intention to remain current on all debt obligations. Pakistan repaid a Sukuk due in December 2022, and the next scheduled bond maturity is not until April 2024, it noted. However, Fitch pointed out that restructuring cannot be fully excluded. 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 percent of the government’s interest burden.”