The government of Pakistan's high debt burden, very narrow revenue base, fragile external payments position and high political risk constrain the credit profile, says the Moody's Investors Service (Moody's). "Political risk in Pakistan remains high, reflecting a high probability of a high impact scenario involving an escalation of violent terrorism or tensions between the different branches of the government which could threaten political stability and divert essential policy and economic resources," said the international credit rating agency in its latest report on Pakistan.
Moody's has assigned a rating of B3 to the government of Pakistan's (B3 stable) US dollar-denominated notes. The senior unsecured notes rank pari passu with all of the Islamic Republic of Pakistan's current and future senior unsecured external debt. The proceeds of the notes are intended for general budgetary purposes.
Pakistan's B3 issuer rating reflects a credit profile that balances robust growth potential and a relatively large economy, against low income levels, infrastructure constraints and very low global competitiveness. In recent years, the credit has been supported by an improved track record of reforms started under an International Monetary Fund (IMF) program, and a stronger outlook for infrastructure investment driven by the China-Pakistan Economic Corridor (CPEC) project. However, the government's high debt burden, very narrow revenue base, fragile external payments position and high political risk constrain the credit profile.
Pakistan's economy demonstrates relatively robust GDP growth, limited by supply-side constraints on the economy. While the scale of the economy is relatively large, Pakistan's per capita income is very low, indicating limited capacity to absorb negative shocks.
Moving forward, implementation of the CPEC will, over time, partly address supply-side constraints through investment in power generation and transport infrastructure, thereby bolstering Pakistan's growth potential and competitiveness. However, security related issues and a weak track record of public project implementation suggest the pace of project execution will be relatively slow.
Pakistan's institutional strength is improving from a very low base, a reflection of significant traction on reforms under and following Pakistan's recent IMF program, which concluded in September 2016, along with improvements in transparency.
Key IMF program goals included fiscal deficit reduction, strengthening of the monetary policy framework, resolving constraints in the energy sector, and state-owned enterprise reform. Continued government commitment to implementation of reforms would help reinforce fiscal and monetary policy discipline, thereby preserving recent macroeconomic stability gains and strengthening institutional effectiveness in the future. Such improvements would help support the sovereign credit profile through enhanced policy credibility and effectiveness.
Progress on these reforms balances key institutional constraints from factious relations among the executive, military and judicial branches of government. Institutional constraints are also reflected in Pakistan's very low rankings in the Worldwide Governance Indicators on government effectiveness, rule of law and control of corruption.
Other factors that drive Pakistan's sovereign credit rating are its very low fiscal strength and high susceptibility to event risk. Key fiscal and external credit metrics are weak intrinsically and relative to ratings peers. These factors are compounded by the country's very narrow revenue base, low savings and shallow capital markets, which hinder debt affordability and increase the debt burden. The material foreign currency portion of outstanding government debt (about 30% of total debt) also exposes the government's balance sheet to foreign exchange risks.
However, the government is lengthening the maturity of debt which will reduce gross financing needs. Government debt rollover risk is also mitigated by sizeable recourse to domestic bank borrowing and, to some degree, by a debt structure that consists of long-tenor credits from multilateral and official bilateral creditors.
The challenging operating environment, susceptibility to economic risks and political shocks, coupled with high exposure of asset quality to the sovereign, links the health of the banking system very closely to that of the government. Banks are generally well managed but remain vulnerable to cyclical economic risks and to political shocks.
Moody's assesses Pakistan's external vulnerability risk as low, reflecting a relatively modest current account deficit, half of which is financed by stable foreign direct investment (FDI). Moreover, foreign exchange reserves cover external debt payments due over the next year. However, external pressures are now building as a result of the recent widening of the current account deficit driven by increased capital goods imports for CPEC, financed in part by external debt, and the slowdown in remittance inflows.
The stable outlook on the issuer rating reflects a balance of positive and negative pressures. On the upside, there is potential for further strengthening in growth beyond our current expectations, as successful implementation of the CPEC project may transform the Pakistani economy by removing infrastructure bottlenecks and stimulating both foreign and domestic investment.
On the downside, the economic benefits of CPEC are still highly uncertain and power supply may continue to constrain growth to a greater extent than the Moody's currently envisages.
Moreover, the fiscal costs related to the project and, more generally, development spending could raise Pakistan's debt burden more rapidly and significantly than the rating agency expects. In addition, recent indications of renewed increases in external pressure could develop into greater external vulnerability.
Upward triggers to Pakistan's rating would stem from sustained progress in structural reforms that would significantly reduce infrastructure impediments and supply-side bottlenecks. This would improve Pakistan's investment environment and eventually aid a shift to a sustained higher growth trajectory. A lasting strengthening in the external liquidity position or meaningful reduction in the government deficit and debt burden would also be credit positive.
Conversely, Moody's would view a stalling of the government's post-IMF program reform agenda, including revenue reforms and the strengthening of monetary policy and central bank independence, to be credit negative. Continued material widening of the fiscal deficit, ongoing weakening of the external payments position, loss of multilateral/bilateral financial support, or significant escalation in political tensions would also weigh on Pakistan's credit profile.
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