Moody’s lowers local, foreign currency issuer, unsecured debt ratings to Caa3

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 Caa3 from Caa1.

Moody’s has also downgraded the rating for the senior unsecured MTN programme to (P) Caa3 from (P) Caa1. Concurrently, Moody’s has also changed the outlook to stable from negative.

The rating agency stated that the decision to downgrade the ratings is driven by its assessment that Pakistan’s increasingly fragile liquidity and external position significantly raises default risks to a level consistent with a Caa3 rating.

In particular, the country’s foreign exchange reserves have fallen to extremely low levels, far lower than necessary to cover its imports needs and external debt obligations over the immediate and medium term.

Although the government is implementing some tax measures to meet the conditions of the IMF programme and a disbursement by the IMF may help to cover the country’s immediate needs, weak governance and heightened social risks impede Pakistan’s ability to continually implement the range of policies that would secure large amounts of financing and decisively mitigate risks to the balance of payments.

The stable outlook reflects Moody’s assessment that the pressures that Pakistan faces are consistent with a Caa3 rating level, with broadly balanced risks.

Significant external financing becoming available in the very near term, such as through the disbursement of the next tranches under the current IMF programme and related financing, would reduce default risk potentially to a level consistent with a higher rating.

However, in the current extremely fragile balance of payments situation, disbursements may not be secured in time to avoid a default.

Moreover, beyond the life of the current IMF programme that ends in June 2023, there is very limited visibility on Pakistan’s sources of financing for its sizeable external payments needs.

The downgrade to Caa3 from Caa1 rating also applies to the backed foreign currency senior unsecured ratings for 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 Caa1 and Caa3 from B2 and Caa1, 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. It also takes into account material risks of transfer and convertibility restrictions being imposed”, it added.

Government liquidity and external vulnerability risks have risen further since Moody’s last review in October 2022. Pakistan’s foreign exchange reserves have declined to a critically low level, sufficient to cover less than one month of imports.

Amid delays in securing official sector funding, risks that Pakistan may not be able to source enough financing to meet its needs for the rest of fiscal 2023 (ending June 2023) have increased.

Beyond this fiscal year, liquidity and external vulnerability risks will continue to be elevated, as Pakistan’s financing needs will remain significant and financing sources are far from secure. At the same time, prospects of the country materially increasing its foreign exchange reserves are low.

Overall, Moody’s estimates that Pakistan’s external financing needs for the rest of the fiscal year ending June 2023 to be around $11 billion, including the outstanding $7 billion external debt payments due. The remainder includes the current account deficit, taking into account a sharp narrowing as imports have contracted markedly.

To meet these financing needs, Pakistan will need to secure financing from the IMF and other multilateral and bilateral partners. Despite recent delays, Moody’s assumes successful completion of the ninth review of the existing IMF programme, although this is not secured yet. This would in turn catalyse financing from other multilateral and bilateral partners.

At the same time, the government will also need to obtain the roll-over of the $3 billion China SAFE deposits and secure $3.3 billion worth of refinancing from Chinese commercial banks for the rest of this fiscal year. Of this $3.3 billion, Pakistan has already received a deposit of $700 million from the China Development Bank on 24 February 2023.

While this year’s external payments needs may be met, the liquidity and external position next year will remain extremely fragile. Pakistan’s external debt repayments will remain high for the next few years. Moody’s estimates Pakistan’s external financing needs for fiscal 2024 are around $35-36 billion.

Pakistan has about $25-26 billion worth of external debt repayments (including interest payments) to make in fiscal 2024, including a $1 billion Eurobond due in April 2024. In addition, Moody’s estimates Pakistan’s current account deficit at around $10 billion.

Pakistan’s financing options beyond June 2023 are highly uncertain. It is not clear that another IMF programme is under discussion and if it does happen, how long the negotiations would take and what conditions would be attached to it. However, in the absence of an IMF programme, Pakistan is unlikely to unlock sufficient financing from multilateral and bilateral partners.

Elevated social risks and weak governance compound the government’s difficulty in advancing further reforms. Households are already facing high and increasing costs of living. Inflation in Pakistan is very high, with food inflation at 42.9% and transport inflation at 39.1 per cent year-on-year in January 2023.

Headline inflation is likely to rise further as energy prices increase in tandem with the removal of energy subsidies. Implementing further measures to raise revenue or cut spending in this environment is extremely socially and politically challenging.

At the same time, reform measures to raise fiscal revenue are likely to remain the key to unlocking further financing from the IMF, as they will help to alleviate debt sustainability risks. In particular, Pakistan has very weak debt affordability.

Moody’s estimates that interest payments will increase to around 50 per cent of government revenue in fiscal 2023 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.

Continued IMF engagement, including beyond the current programme would likely help to support additional financing from other multilateral and bilateral partners, which could reduce default risk, if this is achieved urgently and without further raising social pressures. Conversely, this fiscal year or beyond, financing from the IMF and other partners may not be disbursed in time, which, given the extremely low reserves position, could lead to default.

The rating would likely be upgraded if Pakistan’s government liquidity and external vulnerability risks decreased materially and durably. This could come with a sustainable increase in foreign exchange reserves.

A resumption of fiscal consolidation, including through implementing revenue-raising measures, pointing to a meaningful improvement in debt affordability would also be credit positive.

The rating would likely be downgraded if Pakistan were to default on its debt obligations to private-sector creditors and the expected losses to creditors as a result of any restructuring were larger than consistent with a Caa3 rating.

Copyright Business Recorder, 2023