Fitch Ratings has affirmed Pakistan's long term foreign currency issuer default rating (IDR) at 'B-' with a stable outlook.
Fitch Ratings in its latest report on Pakistan stated that the 'B-' rating reflects a challenging external position characterised by a high external financing requirement and low reserves, weak public finances including large fiscal deficits and a high government debt-to-GDP ratio, and weak governance indicators.
Progress is being made towards strengthening external finances and positive steps have been made on the fiscal front, but considerable risks remain.
The report further stated that external vulnerabilities have been reduced over the past year as a result of policy actions by the authorities and financing unlocked through an IMF programme, which have narrowed the current account deficit and supported a modest rebuilding of reserves. Still, external finances remain fragile with relatively low foreign-exchange reserves in the context of an elevated external debt repayment schedule and subdued export performance. Pakistan's liquidity ratio is 111.4 percent, much weaker than the historic 'B' median of 161.2 percent.
Fitch forecasts a further narrowing of the current account deficit to 2.1 percent of GDP in the year ending June 2020 (fiscal year 2020) and 1.9 percent in fiscal year 2021, from 4.9 percent in the last fiscal year.
Import compression remains the predominant driver of the narrowing deficit, facilitated by a depreciation of the rupee against the US dollar of around 30 percent since December 2017 and tighter monetary conditions. Exports are forecast to grow modestly from a low base. The State Bank of Pakistan's (SBP) adoption of a more flexible exchange rate last May and capital inflows are also supporting a rebuilding of foreign-exchange reserves.
Fitch expects gross liquid foreign-exchange reserves to rise to around $11.5 billion by fiscal year end 2020, from $7.2 billion at fiscal year end 2019. The SBP has also reduced its net forward position by over $3 billion since June, contributing to a considerable improvement in its net foreign-exchange reserves, although these remain negative. Fitch expects continued adherence to the new exchange rate regime to help rebuild foreign-exchange reserves and improve external resilience.
Access to external financing has improved after the approval of a $6 billion, 39-month Extended Fund Facility (EFF) by the IMF board in July 2019. According to the IMF, this has potentially unlocked about $38 billion in financing from multilaterals (including from the IMF) and bilateral sources over the programme period. It may also facilitate financing from offshore capital markets. The EFF is on track, with the first review completed in December. However, implementation risks remain high in Fitch's view, particularly given the politically challenging nature of the authorities' reform agenda.
Gross external financing needs are likely to remain high, in the mid-$20 billion range, over the medium term due to considerable debt repayments and despite the smaller current account deficit. Sustaining inflows to meet these financing needs could prove challenging over a longer horizon without stronger export growth and net FDI inflows.
Public finances are a key credit weakness and deteriorated further in fiscal year 2019 prior to the approval of the IMF programme. The general government deficit slipped to 8.9 percent of GDP in fiscal year 2019, from 6.5 percent in fiscal year 2018, as revenues contracted, due in part to one-off factors, such as lower SBP dividends and delayed telecom licence renewals.
General government debt rose to 84.8 percent of GDP, well above the current 'B' median of 54 percent, due to the currency depreciation, higher fiscal deficit, and build-up of liquidity buffers. Debt/revenue also jumped sharply to 667 percent, compared with the historic 'B' median of 252 percent.
The government is consolidating public finances, but Fitch believes progress will be challenging due to the relatively high reliance on revenues to achieve the planned adjustment.
Fitch stated the revenue target in the fiscal year 2020 budget is ambitious. Nevertheless, the government's efforts to broaden the tax base through its tax-filer documentation drive and removal of GST exemptions will contribute to stronger revenue growth in the current fiscal year.
The passage of the Public Financial Management Act should improve fiscal discipline by limiting the use of supplementary budgets. The government has also taken steps to improve federal-provincial level fiscal coordination through its Fiscal Coordination Council, as the provinces play a key role in the fiscal structure.
Fitch forecasts the fiscal deficit to decline to 7.9 percent of GDP in fiscal year 2020, based on a reversal of the previous year's one-off factors and revenue-enhancing measures. This is slightly higher than the government's expectations of 7.5 percent due to Fitch's more conservative revenue projections.
Fitch expects expenditure to rise, particularly as interest-servicing costs increase sharply on the back of higher interest rates. Further it has projected interest payments/general government revenues of 45 percent in fiscal year 2020, well above the historic peer median of 8.6 percent.
The rating agency forecasts general government debt to GDP will fall to about 80 percent by end-fiscal year 2021 due to faster nominal GDP growth and fiscal consolidation. The government has taken steps to manage domestic debt rollover risks following the cessation of borrowing from the SBP under the EFF.
In particular, the government has re-profiled its SBP debt stock into longer-tenor instruments and has sought to lengthen maturities by issuing longer-term domestic bonds. The government still has roughly 17 percent of GDP in upcoming domestic maturities in fiscal year 2020 compared with the 'B' median of 6 percent, but has built up its cash buffer to partly mitigate rollover risk.
Tighter macroeconomic policies are further slowing GDP growth, which Fitch forecasts at 2.8 percent in fiscal year 2020 from 3.3 percent in fiscal year 2019. It expects growth to recover gradually to 3.4 percent by fiscal year 2021.
Inflation has also continued to rise sharply from the cost pass-through of the currency depreciation and increases in energy tariffs. Fitch forecasts inflation to average 11.3 percent in fiscal year 2020 compared with 6.8 percent in fiscal year 2019.
The SBP is likely to keep the policy rate at the current peak of 13.25 percent in the coming months, before modest cuts towards the end of fiscal year 2020 as inflationary pressures begin to fade.
Improvements to the business and security environment could further support the growth outlook. Domestic security has improved over the past couple of years, measured by a decline in terrorist incidents. Nevertheless, ongoing international perceptions of security risks and geopolitical tensions with neighbouring countries weigh on investor sentiment.
The government has also made progress on business reforms, reflected in the country's move from 136th to 108th in the World Bank's latest Ease of Doing Business survey.
Pakistan's rating is constrained by structural weaknesses, reflected in weak development and governance indicators. Per capita GDP of $1,382 is below the $3,470 median of its 'B' rated peers. Governance quality is also low in Pakistan with a World Bank governance indicator score in the 22nd percentile while the 'B' median is in the 38th percentile.
The main factors that could, individually or collectively, lead to a positive rating action are continued implementation of policies sufficient to facilitate a rebuilding of foreign-exchange reserves and ease external financing constraints, sustained fiscal consolidation, through a structural improvement in revenue, sufficient to put the debt-to-GDP ratio on a downward trajectory, sustained improvements in the business environment and the security situation, which contribute to improved growth and export prospects. The main factors that could, individually or collectively, lead to a negative rating action are reduced access to external finance that causes financing strains.
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