Proposed USD Sukuk certificates: Fitch, Moody’s assign ‘B-’, ‘B3’ ratings, respectively

ISLAMABAD: Fitch Ratings has assigned Pakistan’s proposed US-dollar sovereign global Sukuk certificates, to be issued through The Pakistan Global Sukuk Programme Company Limited, a “B-” rating.

The Pakistan Global Sukuk Programme Company Limited is a legal entity in Pakistan and is the issuer and trustee of the Sukuk, incorporated primarily for the purpose of participating in the Sukuk transaction. It is wholly owned by Pakistan.

The rating agency stated that the rating is sensitive to any changes in Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR), which Fitch affirmed at with a Stable Outlook in May 2021.

Fitch Ratings stated that the certificates rating is driven solely by Pakistan IDR.

This reflects Fitch’s view that a default of these senior unsecured obligations would reflect a default of Pakistan, in accordance with Fitch’s rating definitions.

“We have not considered any underlying assets or collateral provided when assigning a rating to the Sukuk, as we believe the issuer’s ability to satisfy payments due on the certificates will ultimately depend on the Pakistan government satisfying its unsecured payment obligations to the issuer under the transaction documents described in the prospectus and other supplementary documents,” it added.

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The rating agency stated that in addition to the government’s propensity to ensure repayment of the Sukuk, it believes the government would also be required to ensure full and timely repayment of The Pakistan Global Sukuk Programme Company Limited’s obligations due to its various roles and obligations under the Sukuk structure and documentation, especially - but not limited to - the features below: - On each periodic distribution date, Pakistan, acting as a lessee, will pay to the trustee an amount reflecting the rental payable in respect of the lease assets, which is intended to be sufficient to fund the periodic distribution amounts payable by the issuer under the certificates and shall be applied by the trustee for that purpose.

• On any dissolution event, the trustee will have the right to require the obligor, under the purchase undertaking, to purchase the lease assets from the trustee for an amount equal to the exercise price, intended to fund the dissolution distribution amount payable by the issuer under the certificates. The dissolution distribution amount equals (i) the outstanding face amount of such certificate; and (ii) all accrued and unpaid periodic distribution amounts in respect of such certificate, or other amount specified in the applicable pricing supplement as being payable upon the relevant dissolution date.

• In the event of total or partial loss, if there is a short fall from the insurance proceeds, the obligor will be required to pay for the shortfall directly to the transaction account unless the lease assets are replaced. A partial loss dissolution event shall constitute a government event, which in turn shall constitute a dissolution event.

• The payment obligations of the Pakistan government (acting in any capacity) under the transaction documents are direct, unconditional and unsecured obligations and rank pari passu with all other present and future unsecured and unsubordinated external indebtedness of the obligor.

The Pakistan Global Sukuk Programme Company Limited Sukuk includes a negative pledge provision that is binding on the Pakistan government, as well as financial reporting obligations, covenants, government event and cross acceleration terms with external indebtedness. The documentation does not contain a change of control clause.

Certain aspects of the transaction will be governed by English law, while others will be governed by Pakistan law. Fitch does not express an opinion on whether the relevant transaction documents are enforceable under any applicable law.

However, Fitch’s rating for the certificates reflects our belief that the government will stand behind its obligations.

When assigning ratings to Sukuk certificates, Fitch does not express an opinion on their compliance with Shariah principles.

The following ESG issues represent key rating drivers for the Sukuk; other key rating drivers can be found in the issuer rating action commentary dated 27 May 2021:

ESG - Governance: Pakistan has an ESG Relevance Score for both Political

Stability and Rights, and the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators have in our proprietary Sovereign Rating Model. Pakistan has a low World Bank Governance Indicator ranking at 21.2, reflecting a history of volatile political transitions, domestic security incidents, weak institutional capacity, uneven application of the rule of law and a high level of corruption.

The rating on the Sukuk is sensitive to any changes in the Long-Term Foreign-Currency IDR, which has the following rating sensitivities (as per the aforementioned issuer rating action commentary), it added.

Meanwhile, Moody’s Investors Service (Moody’s) has assigned a ‘B3’ backed senior unsecured rating to the proposed US dollar-denominated trust certificates (Sukuk) issuance by the government of Pakistan.

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Through the Pakistan Global Sukuk Programme Company Limited (“the Company”), a special purpose vehicle, which is wholly-owned by the Government of Pakistan and whose debt and trust certificate issuances are, in Moody’s view, ultimately, the obligation of the Government of Pakistan.

The rating agency further stated that the assigned rating to the Sukuk mirrors the Government of Pakistan’s current issuer rating.

According to the terms and conditions available to Moody’s, the trust certificates will constitute direct, unconditional and unsubordinated obligations of the Government of Pakistan.

In Moody’s opinion, the payment obligations represented by the securities to be issued by the Company rank pari passu with all of the Government of Pakistan’s current and future senior unsecured external debt.

Proceeds from the Sukuk issuance will be used by the company to purchase assets from the National Highways Authority (NHA). The amounts subsequently received by the Government of

Pakistan in consideration for the transaction will be used for general budgetary purposes, it added.

Moody’s noted that its Sukuk ratings do not express an opinion on the structure’s compliance with Shariah law.

Pakistan’s B3 issuer rating is underpinned by its relatively large economy and robust long-term growth potential, as well as ongoing reforms that may strengthen policy effectiveness over time.

Credit challenges include structural constraints to export competitiveness, the government’s high debt burden and a narrow revenue base that reduces fiscal flexibility and weakens debt affordability, as well as political risks that can influence the reform trajectory.

The rating agency further stated that Pakistan's ESG Credit Impact Score is Highly Negative (CIS-4), reflecting its high exposure to environmental and social risks, as well as its weak governance profile. Relatively weak institutions constrain the government’s capacity to address ESG risks.

The exposure to environmental risk is Highly Negative (E-4 issuer profile score) because of Pakistan’s vulnerability to climate change and the limited supply of clean, fresh and safe water.

With varied climates across the nation, Pakistan is significantly exposed to extreme weather events, including tropical cyclones, drought, floods and extreme temperatures.

In particular, the magnitude and dispersion of seasonal monsoon rainfall influence the agricultural sector growth and rural household consumption.

The agricultural sector accounts for around 20 percent of GDP and exports, and nearly 40 percent of total employment.

Overall, around 70 percent of the entire population lives in rural areas. As a result, both droughts and floods can create economic, fiscal and social costs for the sovereign.

The exposure to social risk is Highly Negative (S-4 issuer profile score), driven primarily by safety concerns that have limited investment and diversification opportunities. Still very low incomes as well as the limited access to quality healthcare, basic services, housing and education, especially in rural areas, are also important social issues. That said, the government is focused on reducing poverty and inequality, strengthening social safety nets, and promoting human capital as key priorities through its Ehsaas programme, although effects will take time to materialise and are limited by still weak institutions and governance.

The influence of governance is Highly Negative (G-4 issuer profile score). International surveys of various indicators of governance, while showing some early signs of improvement, continue to point to weak rule of law and control of corruption, as well as limited government effectiveness. These weaknesses are balanced against a lengthening track record of effective checks and balances and judicial independence for the level of development in the country, and gradually increasing transparency and dialogue in policymaking.

Upward pressure on Pakistan’s rating would develop if ongoing fiscal reforms were to expand the government’s revenue base, raise debt affordability, and lower its debt burden beyond our current expectations.

A structural reduction in external vulnerability risks, including though higher levels of foreign exchange reserve adequacy that were sustainable and/or increased economic competitiveness that were to lift export prospects, would also put upward pressure on the rating.

Downward pressure on the rating would stem from renewed deterioration in Pakistan’s external position, including through a significant widening of the current account deficit and erosion of foreign exchange reserve buffers, which would threaten the government’s external repayment capacity and heighten liquidity risks.

A continued rise in the government’s debt burden, without prospects for stabilisation over the medium term, would also put downward pressure on the rating. In addition, participation in official sector debt relief programmes that raised the probability of private sector participation would likely point to a lower rating, commensurate with the potential losses to be incurred, Moody’s added.

Copyright Business Recorder, 2022