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March 9, 2018

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Standard Chartered Bank downgrades Pakistan’s credit outlook

KARACHI: Standard Chartered Bank has downgraded credit outlook on Pakistan, citing concerns over widening twin-deficit and high external funding needs that could force the country to tap the international bond market soon.

“We change our credit outlook on Pakistan to Negative from Stable currently,” said Standard Chartered Bank in a report tilted Pakistan—External financing blues, issued on Wednesday.

The bank said "the chances of an International Monetary Fund (IMF) programme have increased, but it’s not a done deal and it’s unlikely before elections in the second half of 2018". “Pakistan will likely borrow more from the bond markets to bridge the C/A (current account) gap and replenish reserves.”

It said the bigger worry was the rapid depletion of reserves – gross official reserves (including gold) declined to $17.02 billion in January 2018 from $20.04 billion in June 2017, despite the $2.5 billion sovereign bond issue in late November 2017.

“We expect Pakistan to return to the market to replenish its reserves before the end of the fiscal year,” the bank forecasted.

A persistently high C/A deficit over the last few years, funded by government bonds and short-term loans, has led to increasing external financing requirements for Pakistan.

The IMF estimates a total $13.6 billion of external financing for fiscal year 2017-18 (FY18) and a further $16.9 billion for next fiscal year.

“Based on our C/A deficit estimates, the external financing requirement would rise to $19.6 billion and $18.9 billion respectively. We estimate the FY18 C/A deficit at 5.3 percent; the actual July-January FY18 deficit came in at 4.7 percent, a sharp increase from 3.5 percent for the same period in FY17,” the bank said. The overall FY17 C/A deficit stood at 4.1 percent.

About the possibility of the new IMF program, the bank said the IMF has asked for more permanent flexibility in the exchange rate and a continued tight monetary bias to address external imbalances.

“Any potential program would require extensive commitment on revenue-led fiscal consolidation and structural reforms to address the weakening current account,” the bank said.

The report also said that bilateral support from China should be forthcoming, but there were no details yet on increasing swap lines. “In the meanwhile, Pakistan may have to depend on bilateral sources to bridge the widening C/A gap. Pakistan currently has a swap line with China for RMB 10 billion, which is almost fully drawn.”

It added that Pakistan has also received financial support from the Gulf Cooperation Council (GCC) states in the past, especially Saudi Arabia. “Its recent decision to send troops to Saudi Arabia could be a precursor to some kind of financial support from the region as well.”

The report, however, warned that the workers’ remittances from the Middle East could be pressured by the changing political situation in the region.

“Workers’ remittances – the biggest source of foreign exchange to bridge the large gap in the goods, services and income account – have failed to keep pace with the growing goods and services gap,” it said.

“The lion’s share of these remittances (60 percent) comes from the Middle East; we expect pressure on this front as lower oil prices and increased pressure on localisation of the workforce in the region reduce Middle Eastern countries’ reliance on workers from South Asia.”

The report said while some of the gap in the current account (CPEC-related) is being funded by increased foreign direct investment (FDI) – mainly from China – a large portion is being funded by debt.

“This has led to a rise in Pakistan’s overall external debt – to 27.3 percent of GDP in December 2017 from 24.8 percent in December 2015 – which we believe will increase further,” the bank said in the report.

“That said, Pakistan’s overall external debt level remains much lower than the median for Single-B or even BB-rated sovereigns.”

The report also raised alarm that external sector poses risks to the growth outlook.

“We maintain our 5.5 percent growth forecast for FY18 (year ending June 2018), but note growing downside risks from the external sector. Policy makers recently allowed a marginally higher USD-PKR and hiked interest rates.”

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