Fitch says Pakistan’s political volatility adds to external financing risk

Fitch Ratings has said that the recent government change in Pakistan has been peaceful, but raises near-term policy uncertainty even as the country faces external and fiscal challenges from rising commodity prices and an increase in global risk aversion.

The American credit ratings agency in its latest report said that the authorities’ policy agenda remains central to Pakistan’s ability to refinance its external debt over the medium term, as well as its assessment of the rating, which was affirmed at ‘B-’/Stable in February 2022.

The report comes as Pakistan witnessed a series of major political developments, which saw Pakistan Muslim League-Nawaz (PML-N) President Shehbaz Sharif take over as the country's 23rd prime minister after Imran Khan was ousted through a no-confidence vote over the weekend.

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“His (Imran Khan's) ultimate acceptance of the Supreme Court’s verdict that it should go ahead and the outcome of the vote strengthens the legitimacy of constitutional mechanisms,” said Fitch Ratings.

Fitch believes Pakistan has the ability to manage its external liquidity position in the near term if policy uncertainty is resolved relatively quickly and commodity prices do not rise substantially

Fitch was of the view that the new government may complicate the timely completion of the remaining three reviews of the International Monetary Fund (IMF) programme as negotiations around key revenue-raising reforms could prove lengthy, particularly as the government is a broad coalition of disparate political parties.

The agency said that the recent oil price shock will push up Pakistan’s current-account deficit, adding to already high gross external financing needs from an elevated debt-repayment schedule.

“We now forecast a current-account deficit of around 5% of GDP (around $18.5 billion) for the fiscal year ending June 2022 (FY22), up from 4% in our February review. We expect this to moderate to around 4% in FY23, as oil prices ease.”

Fitch said that it also expects the rollover of the $7 billion in Chinese and Saudi deposits, a development that is key to give respite to Pakistan's foreign exchange reserves.

It said that higher trade deficits and capital outflows have driven a sharp depreciation of the Pakistani rupee against the US dollar. This, along with debt repayments, has put pressure on liquid foreign-exchange reserves held with the State Bank of Pakistan (SBP), which fell by $5.1 billion between end-February and 1 April 2022, to $11.3 billion.

“We believe the decline also partly reflects repayment of a $2.4 billion loan from China that is slated to be renewed,” it said.

Fitch expressed that the previous government’s implementation of reforms in line with an IMF programme helped underpin its access to global debt markets, as Pakistan successfully carried out the issuance of a $1 billion Sukuk in January 2022.

However, since then, Pakistan’s access to private creditor finance has been challenged by external factors, such as rising US interest rates and heightened investor risk aversion around the Ukraine conflict, it said.

“We believe setbacks to reform or the IMF programme would make access even more difficult,” said Fitch.

Fitch believes Pakistan has the ability to manage its external liquidity position in the near term if policy uncertainty is resolved relatively quickly and commodity prices do not rise substantially above our forecasts for 2022-2023.

“We expect its access to bilateral financing to remain robust, particularly from China,” it said, as the two countries’ strong bilateral relationship is unlikely to be significantly weakened by political changes.

However, the change in government will test how institutionalised recent reforms, such as the independence of the SBP and the more market-determined exchange rate, Fitch said.

“We would view slippage on reform momentum as credit negative. In the longer term, if the authorities are unable to pursue fiscal consolidation, we expect Pakistan’s access to market financing to remain constrained,” the rating agency said.