Fitch affirms Pakistan B- rating with a stable outlook

KARACHI: Global credit rating agency Fitch Ratings on Monday affirmed Pakistan’s long term foreign currency rating at B- with a stable outlook, saying the country has taken positive steps on fiscal front as well as measures to strengthen external finance.

“Progress is being made towards strengthening external finances and positive steps have been made on the fiscal front, but considerable risks remain,” the New York-based rating agency said. Fitch said external vulnerabilities have been reduced over the past year as a result of policy actions and financing unlocked through an International Monetary Fund (IMF) programme, which have narrowed the current account deficit and supported a modest rebuilding of reserves. “Still, external finances remain fragile with relatively low foreign-exchange reserves in the context of an elevated external debt repayment schedule and subdued export performance,” it noted. The IMF’s Extended Fund Facility is on track, with the first review completed in December. However, implementation risks remain high in Fitch’s view, particularly given the politically challenging nature of the authorities’ reform agenda. Fitch forecasts a further narrowing of the current account deficit to 2.1 percent of GDP in the year ending June 2020 (FY20) and 1.9 percent in FY21, from 4.9 percent in the last fiscal year. It held import compression as the driver narrowing deficit, facilitated by rupee depreciation of around 30 percent since December 2017 and tighter monetary conditions. Exports were forecast to grow modestly from a low base.

The State Bank of Pakistan's (SBP) adoption of a more flexible exchange rate last May and capital inflows were also supporting a rebuilding of foreign-exchange reserves. Fitch expects gross liquid foreign-exchange reserves to rise to around $11.5 billion by FYE20, from $7.2 billion at FYE19.

“We expect continued adherence to the new exchange rate regime to help rebuild foreign-exchange reserves and improve external resilience,” Fitch said.

The agency said gross external financing needs of the country would likely remain high, in the mid-$20 billion range, over the medium-term due to considerable debt repayments and despite smaller current account deficit. “Public finances are a key credit weakness and deteriorated further in FY19 prior to the approval of the IMF programme,” it noted.

Fitch said government debt rose to 84.8 percent of GDP, well above the current ‘B’ median of 54 percent, due to currency depreciation, higher fiscal deficit, and build-up of liquidity buffers. Debt/revenue also jumped sharply to 667 percent, compared with the historic ‘B’ median of 252 percent.

The government was consolidating public finances, but Fitch believes progress would be challenging due to the relatively high reliance on revenues to achieve the planned adjustment. Fitch believes the revenue target in the FY20 budget was ambitious. “Nevertheless, the government’s efforts to broaden the tax base through its tax-filer documentation drive and removal of GST exemptions will contribute to stronger revenue growth in the current fiscal year,” the rating agency said.

Fitch forecasts the fiscal deficit to decline to 7.9 percent of GDP in FY20, based on a reversal of the previous year’s one-off factors and revenue-enhancing measures.

“We expect expenditure to rise, particularly as interest-servicing costs increase sharply on the back of higher interest rates,” Fitch said. “We project interest payments/general government revenues of 45 percent in FY20, well above the historic peer median of 8.6 percent.”

“We forecast general government debt to GDP will fall to about 80 percent by end-FY21 due to faster nominal GDP growth and fiscal consolidation. Fitch said tighter macroeconomic policies were further slowing GDP growth, and it forecasted 2.8 percent growth in FY20 from 3.3 percent in FY19. “We expect growth to recover gradually to 3.4 percent by FY21.” Inflation has also continued to rise sharply from the cost pass-through of the currency depreciation and increases in energy tariffs. Fitch forecasts inflation to average 11.3 percent in FY20 compared with 6.8 percent in FY19.

“The SBP is likely to keep the policy rate at the current peak of 13.25 percent in the coming months, before modest cuts towards the end of FY20 as inflationary pressures begin to fade.”