Moody's Investors Service (Moody's) has placed the government of Pakistan's local and foreign currency long-term issuer and senior unsecured B3 ratings under review for downgrade.
Moody's in its latest report on Pakistan stated that the decision to place the ratings under review for downgrade reflects its expectation that the government will request for bilateral official sector debt service relief under the recently announced G20 initiative.
Suspension of debt service obligations to official creditors would be unlikely to have rating implications; indeed such relief would increase the fiscal resources available to the government for essential health and social spending due to the Coronavirus outbreak.
However, the G20 has called on private sector creditors to participate in the initiative on comparable terms. Consistent with Moody's approach globally, the review period will allow the rating agency to assess whether Pakistan's participation in the initiative would likely entail default on private sector debt, notwithstanding the intended voluntary nature of private sector participation and the fact that the country has not, to Moody's knowledge, indicated interest in extending the debt service relief request to the private sector; and, if so, whether any losses expected to arise from that participation would be consistent with a lower rating.
The report further stated that the rapid spread of the Coronavirus, sharp deterioration in global economic outlook, and significant reduction in risk appetite are creating a severe economic and financial shock. For Pakistan, the current shock transmits mainly through a sharp slowdown in economic activity, lower tax revenue as economic activity slows, and higher government financing needs relative to pre-coronavirus levels. However, ongoing reforms that pointed to nascent improvement in credit fundamentals before the outbreak and financing from development partners contain the pressure on the sovereign's liquidity and external positions.
Concurrently, Moody's has also placed the B3 foreign currency senior unsecured ratings for The Third Pakistan International Sukuk Co Ltd under review for downgrade. The associated payment obligations are, in Moody's view, direct obligations of the government of Pakistan.
Pakistan's Ba3 local currency bond and deposit ceilings remain unchanged. The B2 foreign currency bond ceiling and the Caa1 foreign currency deposit ceiling are also unchanged. The short-term foreign currency bond and deposit ceilings remain unchanged at Not-Prime. These ceilings act as a cap on the ratings that can be assigned to the obligations of other entities domiciled in the country.
The driver for the review for downgrade is Moody's expectation that Pakistan will request bilateral debt service relief from G20 creditors under the recently announced initiative and the associated possibility of losses to private sector creditors.
The initiative offers benefits for the world's poorest nations, many of which have large external payment obligations and are exposed to outflows of capital and depreciating exchange rates during this unprecedented shock. Additional financial support and liquidity relief will allow fiscal resources to be devoted to essential health efforts and towards minimizing the economic and social impact of the outbreak.
However, the G20 has called on private sector creditors to participate in the initiative on comparable terms. This suggests that, for the countries that elect to seek official sector debt service relief, the initiative may also lead to the suspension of payments or renegotiation of private sector debt service obligations. It is in this context that Moody's has placed Pakistan's ratings under review, in line with the rating agency's approach globally.
During the review period, Moody's will assess whether Pakistan's participation in the initiative will indeed be implemented without private sector participation, consistent with the intended voluntary nature of private sector participation, or whether any losses may be expected to arise for private sector creditors that would be consistent with a lower rating. Pakistan has not indicated any interest in extending the debt service relief to include private sector creditors.
At this stage, Moody's assesses that the main impact of the Coronavirus shock is on Pakistan's economic growth, which raises fiscal challenges and delays the government's fiscal consolidation and debt reduction efforts. Ongoing and significant financial and technical supports from development partners, as well as the effective use of monetary policy, mitigate the impact of the shock on the sovereign's liquidity and external positions.
The Pakistani economy is relatively closed, with low reliance on exports and private capital inflows and limited trade linkages. However, the Coronavirus outbreak presents a significant shock to the domestic economy in part due to the measures aimed at restricting the movement of people to prevent the spread of the virus. Moody's expects Pakistan's economy to contract by around 1 percent in fiscal 2020 (ending June 2020), and to grow by 2-3 percent in fiscal 2021 - below potential.
The economic slowdown will weigh on government revenue and modestly raise spending, in turn pushing the fiscal deficit wider to close to 10 percent of GDP in fiscal 2020. As a result, Moody's projects the government's debt burden to reach around 85-90 percent of GDP in fiscal 2020. However, the government's commitment to fiscal reforms, including under its 2019-22 International Monetary Fund programme, provides a crucial anchor for the continued expansion of its revenue base when economic activity gradually normalizes. Overall, Moody's expects that the debt burden will return to a downward trend after the initial shock.
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