Moody's Investors Service said in a report on Pakistan on Friday that weak governance, political tensions and flaws in the legal system will undermine institutions and policy-makers, and heighten risks of sudden shifts in private investor confidence.
The credit rating agency, however, went on to justify maintaining a stable outlook on Pakistan's rating as the structure of government debt largely consists of long-term credits from official bilateral and multilateral lenders, "which adds stability and reduces rollover risks".
Last month, Moody's and Standard & Poors both cut Pakistan's credit ratings to five levels below investment-grade. S&P, however, opted for a negative outlook. There is concern over the size of the fiscal and current account deficits - under pressure from soaring import costs - and worry that the political uncertainty hanging over Pakistan's 2-month old coalition government could undermine policy making and implementation.
Moody's said "renewed political discord is unlikely to provide the stable and orthodox policy framework necessary for quickly limiting these macroeconomic imbalances."
The statement came two days after the government announced budget proposals for 2008/09 (July/June), setting a target to cut the fiscal deficit to 4.7 percent of gross domestic product and the current account deficit to 6.0 percent.
The government said the fiscal deficit is expected to be 7.0 for fiscal year of 2007/08, and the central bank has forecast the current account deficit at between 7.3 and 7.8 percent for the year ending June 30. The government announced in the budget they would gradually withdraw food and oil subsidies from the current 405 billion rupees to 293 billion rupees.
Slashing subsidies would further increase inflation and data released earlier this week showed consumer prices rose 19.27 percent year-on-year in May, the highest in over three decades. The government has set a 12 percent target for inflation in 2008/09. Analysts say it will be almost impossible to achieve if subsidies on oil and food are withdrawn.
A day earlier, ratings agency Standard & Poor's said the budget would have no impact on ratings and was in line with expectations, adding the rating would be lowered if fiscal and current account deficits do not improve.
Analysts were unsurprised by the rating agencies stance. "This was more or less expected," said Asif Qureshi, head of research at Invisor Securities Ltd. "The government needs to take actions immediately to build its credibility among multilateral and rating agencies."
The country's stock market and the rupee remained largely unaffected by the statements released by the ratings agencies as dealers said this came as no surprise and foreign interest has been lacking since last month due to mounting political and economic uncertainty. The Karachi Stock Exchange is down 8.1 percent since the start of the year, while the rupee has depreciated 8 percent.
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