Federal Finance Minister Ishaq Dar congratulated Prime Minister Shehbaz Sharif and the nation for the upgradation of Pakistan’s Long Term Foreign-Currency rating to CCC for Issuer Default Rating (IDR) from the global rating agency “Fitch” on Monday.
According to the 24News HD TV channel, Ishaq Dar shared the report of the new rating of Pakistan from “Fitch” on his social media account Twitter and terms it another positive sign towards the current economic revival in the country.
The federal finance minister also congratulated the nation, all allied parties of his coalition government and his economic team for the upgradation of the rating Pakistan in the global rating agency.
Fitch Report In Detail:
Fitch Ratings has upgraded Pakistan's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'CCC' from 'CCC-'. Fitch typically does not assign Outlooks to sovereigns with a rating of 'CCC+' or below.
KEY RATING DRIVERS
Easing External Financing Risks: The upgrade reflects Pakistan's improved external liquidity and funding conditions following its Staff-Level Agreement (SLA) with the IMF on a nine-month Stand-by Arrangement (SBA) in June. We expect the SLA to be approved by the IMF board in July, catalysing other funding and anchoring policies around parliamentary elections due by October. Nevertheless, programme implementation and external funding risks remain due to a volatile political climate and large external financing requirement.
IMF-Driven Reforms: Pakistan has recently taken measures to address shortfalls in government revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate, including import financing restrictions. These issues held up the last three reviews of Pakistan's previous IMF programme, before its expiry in June.
Most recently, the government amended its proposed budget for the fiscal year ending June 2024 (FY24) to introduce new revenue measures and cut spending, following additional tax measures and subsidy reforms in February. The authorities appeared to abandon exchange-rate management in January 2023, although guidelines on prioritising imports were only removed in June.
Implementation Risks: Pakistan has an extensive record of going off-track on its commitments to the IMF. We understand the government has already made all the required policy actions under the SBA. Nevertheless, there is still scope for delays and challenges to implementation as well as new policy missteps ahead of the October elections and uncertainty over the post-election commitment to the programme.
New Funding Unlocked: IMF board approval of the SBA will unlock an immediate disbursement of USD1.2 billion, with the remaining USD1.8 billion scheduled after reviews in November and February 2024. Saudi Arabia and the United Arab Emirates have committed another USD3 billion in deposits, and the authorities expect USD3-5 billion in other new multilateral funding after the IMF agreement. The SBA should also facilitate disbursement of some of the USD10 billion in aid pledges made at the January 2023 flood relief conference, mostly in the form of project loans (USD2 billion in the budget).
Overall Funding Targets Ambitious: The authorities expect USD25 billion in gross new external financing in FY24, against USD15 billion in public debt maturities, including USD1 billion in bonds and USD3.6 billion to multilateral creditors. The government funding target includes USD1.5 billion in market issuance and USD4.5 billion in commercial bank borrowing, both of which could prove challenging, although some of the loans not rolled over in FY23 could now return. USD9 billion in maturing deposits from China, Saudi Arabia and the UAE will likely be rolled over, as in FY23.
Narrower External Deficit: Pakistan's current account deficit (CAD) has narrowed sharply, driven by earlier restrictions on imports and FX availability, tighter fiscal and economic policies, measures to limit energy consumption and lower commodity prices. Pakistan posted current account surpluses in March-May 2023, and we forecast a CAD of about USD4 billion (1% of GDP) in FY24, after USD3 billion in FY23 and over USD17 billion in FY22. Our forecast CAD is lower than the USD6 billion in the budget, on the assumption that not all of the planned new funding will materialise, constraining imports.
External Deficit Risks: The CAD could widen more than we expect, given continued reports of import backlogs, the dependence of the manufacturing sector on foreign inputs, and reconstruction needs after last year's floods. Nevertheless, currency 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 partly switching to unofficial channels to benefit from more favourable parallel market exchange rates.
The 'CCC' Long-Term Foreign-Currency IDR also reflects the following factors:
Reserves Still Low: Liquid net FX reserves of the State Bank of Pakistan have hovered around USD4 billion since February 2023, or less than a month of imports, down from a peak of more than USD20 billion at end-August 2021. The collapse in reserves reflected large CADs, external debt servicing and earlier FX intervention by the central bank. We expect a modest recovery for the rest of FY24 on new external financing flows, although these flows will also lead to a renewed widening of the CAD.
Volatile Politics: Protests by supporters of former prime minister Imran Khan and his PTI party sharply intensified in May as Mr Khan was briefly arrested on corruption charges, culminating in attacks on army facilities. In the ensuing crackdown, a large number of PTI members were arrested, with several high-ranking PTI politicians quitting politics. Nevertheless, the enduring popularity of Mr Khan and PTI create policy uncertainty around elections.
Fiscal Deficits Remain Wide: We expect the consolidated general government (GG) fiscal deficit to widen to 7.6% of GDP in FY24, from an estimated 7.0% in FY23, driven by higher interest costs on domestic debt, which accounts for the difference between our forecast and a GG deficit of 7.1% of GDP in the revised FY24 budget statement (with a lower figure of 6.5% in the medium-term fiscal framework). Fiscal consolidation will drive a slight improvement in our forecast GG primary deficit to 0.1% of GDP in FY24, from 0.5% of GDP in FY23.
High, Stable Debt Level: The GG debt/GDP of 74% at FYE23 is in line with the median for 'B', 'C' and 'D' rating category sovereigns and debt dynamics are broadly stable owing to high nominal growth over the medium term. Nevertheless, debt/revenue (over 600%) and interest/revenue (nearly 60%) are far worse than that of peers.
Government Considering Bilateral Maturity Extension: The finance minister recently said that Pakistan would seek maturity extensions on loans by non-Paris club bilateral creditors, while reaffirming the government's commitment to timely debt service. We understand that such maturity extensions would mostly relate to loans and deposits by China, Saudi Arabia and the UAE, which are already regularly rolled over.
In 2022, the prime minister and former finance minister raised the possibility of seeking debt relief from non-commercial creditors, including the Paris Club, but the authorities now appear to have moved away from this. Should Paris Club debt treatment be sought, Paris Club creditors are likely to require comparable treatment for private external creditors in any restructuring.
ESG - Governance: Pakistan has an ESG Relevance Score (RS) of '5' for both political stability and rights and for the rule of law, institutional and regulatory quality and control of corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Pakistan has a WBGI ranking at the lower 22nd percentile.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
- Public Finances: Increasing likelihood of default, for example renewed deterioration in external liquidity conditions that could result from delays in IMF disbursements, or indications that the authorities are considering debt restructuring.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
- Public Finances: Strong performance against IMF programme conditions, ensuring continued availability of funding.
- External Finances: Rebuilding of foreign-currency reserves and further easing of external financing risks.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Pakistan a score equivalent to a rating of 'CCC+' on the Long-Term Foreign-Currency IDR scale. However, in accordance with its rating criteria, Fitch's sovereign rating committee has not utilized the SRM and QO to explain the ratings in this instance. Ratings of 'CCC+' and below are instead guided by the rating definitions.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Pakistan has an ESG Relevance Score of '5' for political stability and rights, as WBGIs have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Pakistan has a percentile rank below 50 for the respective governance indicator, this has a negative impact on the credit profile.
Pakistan has an ESG Relevance Score of '5' for rule of law, institutional & regulatory quality and control of corruption, as WBGIs have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Pakistan has a percentile rank below 50 for the respective governance indicators, this has a negative impact on the credit profile.
Pakistan has an ESG Relevance Score of '4' for human rights and political freedoms, as the voice and accountability pillar of the WBGIs is relevant to the rating and a rating driver. As Pakistan has a percentile rank below 50 for the respective governance indicator, this has a negative impact on the credit profile.
Pakistan has an ESG Relevance Score of '4' for creditor rights, as a willingness to service and repay debt is relevant to the rating and is a rating driver for Pakistan, as for all sovereigns. As Pakistan participated in the Debt Service Suspension Initiative in 2020, this has a negative impact on the credit profile.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity.
For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg