ISLAMABAD: Moody’s Investors Service (Moody’s) has downgraded the government of Pakistan’s local and foreign currency issuer and senior unsecured debt ratings to Caa1 from B3.
Moody’s has also downgraded the rating for the senior unsecured MTN programme to (P) Caa1 from (P) B3. The outlook remains negative.
The decision to downgrade the ratings to Caa1 is driven by increased government liquidity and external vulnerability risks and higher debt sustainability risks, in the aftermath of devastating floods that hit the country since June 2022.
The floods have exacerbated Pakistan’s liquidity and external credit weaknesses and vastly increase social spending needs, while government revenue is severely hit.
The rating agency stated that debt affordability, a long-standing credit weakness for Pakistan, will remain extremely weak for the foreseeable future.
The Caa1 rating reflects Moody’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 access to 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.
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The negative outlook captures risks around Pakistan’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 adds 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 Caa1 rating also applies to the backed foreign currency senior unsecured ratings for The Third Pakistan International Sukuk Co Ltd and The Pakistan Global Sukuk Programme Co Ltd. The associated payment obligations are, in Moody’s view, direct obligations of the Government of Pakistan. Concurrent to today’s action, Moody’s has lowered Pakistan’s local and foreign currency country ceilings to B2 and Caa1 from B1 and B3, respectively.
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 point to material transfer and convertibility risks notwithstanding moderate external debt.
The rating agency further stated that Pakistan’s economic outlook in the near and medium term has deteriorated sharply as a result of the floods. The government’s preliminary estimates put the economic cost of the floods at about $30 billion (10% of GDP), far above the estimated $10 billion economic cost of the 2010 floods, which was until now the country’s worst flooding episode.
Moody’s has lowered Pakistan’s real GDP growth to 0-1 per cent for fiscal 2023 (the year ending in June 2023), from a pre-flood estimate of 3-4 per cent. 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. As the economy recovers from the floods, Moody’s expects growth to pick up next year but stay below trend.
The supply shock due to the floods will increase prices further, at a time when inflationary pressures are already elevated. The monthly inflation rate averaged 25 per cent from July-September 2022. Moody’s expects inflation to pick up to 25-30 per cent on average for fiscal 2023, compared to a pre-flood estimate of 20-25 per cent.
It further stated that payments will increase to around 50 per cent in fiscal 2023, from 40 per cent of government revenue in fiscal 2022, and stabilise at this level for the next few years. A significant share of revenue going towards interest payments will increasingly constrain the government’s capacity to service its debt while also meeting the population’s essential social spending needs. Because of the narrow revenue base, the government’s debt as a share of revenue is very high at about 600 per cent in fiscal 2022. Moody’s expects this ratio to rise further to 620-640 per cent in fiscal 2023, well above the median of 320 per cent for Caal-rated sovereigns, despite a more moderate debt-to-GDP ratio at 65-70 per cent in fiscal 2023.
External liquidity conditions have also tightened significantly for Pakistan. Its access to market financing at affordable cost is extremely constrained, and will likely remain so for some time. Therefore, Pakistan will remain highly reliant on financing from multilateral and bilateral partners. Moody’s expects Pakistan’s continued engagement with the IMF to enable it to access financing from the IMF and related financing from other multilateral partners and official creditors.
Moody’s understands that the government has secured additional commitments from multilateral partners to meet higher financing needs due to the floods. Nonetheless, 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.
Moreover, while Moody’s assumes that access to official sector financing will be maintained and will be enough to meet Pakistan’s needs, lower financing and/or higher needs would raise the risk of default to a level no longer consistent with a Caa1 rating.
Copyright Business Recorder, 2022
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