Moody's cuts Pakistan's rating to Caa1

Moody's Investors Service cut Pakistan's sovereign credit rating on Thursday by one notch to Caa1 from B3, citing increased government liquidity and external vulnerability risks, following the devastating floods that hit the country earlier this year.

The floods, caused by abnormal monsoon rains and glacial melt, have submerged huge swathes of the South Asian country and killed nearly 1,700 people, most of them women and children.

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The floods will also raise Pakistan's external financing needs, raising the risks of a balance of payments crisis, according to the rating agency.

Moody's outlook on Pakistan remained unchanged at negative.

It said the Caa1 rating reflected the agency's view that Pakistan will remain highly reliant on financing from multilateral partners and other official sector creditors to meet its debt payments, in the absence of market financing at affordable costs.

“In particular, Moody’s expects that Pakistan’s IMF Extended Fund Facility (EFF) program will remain in place and provide an avenue for financing from the IMF and other multilateral and bilateral partners in the near term.”

Moody's downgrades Pakistan's outlook to negative from stable

The rating agency explained that the negative outlook captured risks around the country’s ability to secure required financing to fully meet its needs in the next few years.

“Elevated social and political risks compound the government’s difficulty in implementing reforms, including revenue-raising measures, that would improve the country’s fiscal position and alleviate liquidity stresses.

“The floods will also raise Pakistan’s external financing needs, raising the risks of a balance of payments crisis. Pakistan’s weak institutions and governance strength add uncertainty around whether the country will maintain a credible policy path that supports further financing. The negative outlook also captures risks that, should a debt restructuring be needed, it may extend to private sector creditors,” the statement said.

Moody's has also lowered Pakistan's local and foreign currency country ceilings to B2 and Caa1 from B1 and B3, respectively.

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"The two-notch gap between the local currency ceiling and sovereign rating is driven by the government's relatively large footprint in the economy, weak institutions, and relatively high political and external vulnerability risk.

"The two-notch gap between the foreign currency ceiling and the local currency ceiling reflects incomplete capital account convertibility and relatively weak policy effectiveness, which points to material transfer and convertibility risks notwithstanding moderate external debt," the statement said.

It said that the expected "growth shock" will lower government revenues, while government expenditures will be raised by the costs of rescue and relief operations in the wake of floods.

"Moody's expects the fiscal deficit to widen to 7-8% of GDP for fiscal 2023, from a pre-food estimate of 5-6% of GDP. Pressures on public finances are likely to persist in the next few years, as expenditures remain high because of reconstruction and social needs," it said.

"Moody’s has lowered Pakistan’s real GDP growth to 0-1pc for fiscal 2023 (the year ending in June 2023), from a pre-flood estimate of 3-4pc. The floods will affect all sectors, with the impact likely more acute in the agriculture sector, which makes up about one-quarter of the economy.”

Accordingly, it said, Pakistan's debt affordability – which is already one of the weakest among the sovereign's Moody's rate – will worsen.

"Against a backdrop of increasing interest rates and weaker revenue collection, Moody estimates that interest payments will increase to around 50% in fiscal 2023, from 40% of government revenue in fiscal 2022, and stabilize at this level for the next few years.

"A significant share of revenue going toward interest payments will increasingly constrain the government's capacity to service its debt while also meeting the population's essential social spending needs," it added.

It said that due to the narrow revenue base, the government's debt as a share of revenue is very high at about 600% in fiscal 2022.

"Moody's expects this ratio to rise further to 620-640% in fiscal 2023, well above the median of 320% for Caa-rated sovereigns, despite a more moderate debt to GDP ratio at 65-70% in fiscal 2023."

Explaining the rationale for maintaining the negative outlook, it said the downside captures the risks beyond what would be consistent with a Caa1 rating.

"Elevated social and political risks compound the government's difficulty in implementing reforms, including revenue-raising measures, that would improve the country's fiscal position and alleviate liquidity stresses.

"Moreover, as mentioned above, Pakistan faces risks of a balance of payments crisis, which would increase if its external payments needs are higher than currently expected, for instance, because of larger import needs, while access to external financing is more restricted," the agency explained.

Further elaborating on its decisions, the rating agency said: "While the current account deficit widens, Pakistan's foreign exchange reserves have remained at very low levels, sufficient to cover less than two months of imports even after the recent IMF disbursement of $1.1 billion from the seventh and eighth review of the EFF programme.

"Moody's understands that the government has secured additional commitments from multilateral partners to meet higher financing needs due to the flood," it said.

Restating its concerns, the agency said: "Risks remain in particular related to Pakistan's weak institutions and governance strength which adds uncertainty about the sovereign's capacity to maintain a credible and effective policy stance."