Investment rating agency says improvement driven by expectations that balance of payments will continue to improve
The Moody’s Investors Service on Monday upgraded Pakistan’s credit rating outlook to stable, with an accompanying report saying it reflected the country’s relatively large economy and robust growth potential.
The announcement, which pushed Pakistan’s stock market above 40,000 points, also affirmed the Government of Pakistan’s local and foreign currency long-term issuer and senior unsecured debt ratings at B3.
“The change in outlook to stable is driven by Moody’s expectations that the balance of payments dynamics will continue to improve, supported by policy adjustments and currency flexibility,” said Moody’s while announcing the change. “Such developments reduce external vulnerability risks, although foreign exchange reserve buffers remain low and will take time to rebuild.” It added that while fiscal strength remained low due to currency devaluation, ongoing fiscal reforms were expected to mitigate risks related to debt sustainability and government liquidity.
However, while Moody’s praised Pakistan’s growth potential and effectiveness, it noted that fiscal strength would remain weak over the foreseeable future due to structural constraints to economic and export competitiveness and the government’s low revenue generation capacity.
“Pakistan’s Ba3 local currency bond and deposit ceilings remain unchanged,” said the report. “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.”
Noting that foreign exchange reserve adequacy would take time to rebuild, the report said Moody’s “expects Pakistan’s current account deficit to continue narrowing in the current and next fiscal year (ending June of each year), averaging around 2.2% of GDP, from more than 6% in fiscal 2018 (the year ending June 2018) and around 5% in fiscal 2019.” It said that Moody’s baseline assumptions showed “subdued import growth” would likely remain the main driver of narrowing current account deficits. “Currently tight monetary conditions and import tariffs on nonessential goods will also weigh on broader import demand for some time, although Moody’s sees the possibility of monetary conditions easing when inflation gradually declines towards the end of the current fiscal year,” it added.
Moody’s said it expects Pakistan’s exports to pick up due to the real exchange rate depreciation over the past 18 months. It said the government’s focus on raising the country’s trade competitiveness, if effective, would eventually result in growth in exports. The report also pointed to strengthened independence for the State Bank of Pakistan and the commitment to currency flexibility to support the reduction in external vulnerability risks.
But while it praised the government’s macroeconomic indicators, Moody’s clarified that risks remained. “Moody’s expects the government’s fiscal deficit to remain relatively wide at around 8.6% of GDP in fiscal 2020, compared to 8.9% in fiscal 2019, before narrowing to an average of around 7% over fiscal 2021-23. High interest payments owing to policy rate hikes will continue to weigh on government finances and significantly constrain fiscal flexibility,” it said, adding that the revenue growth targets set by the IMF program were challenging to achieve in full in a subdued economic growth environment. “In particular, Moody’s expects Pakistan’s GDP growth to slow to 2.9% in fiscal 2020 from 3.3% last fiscal year, given tight financial conditions that continue to weigh on domestic demand, before rising to 3.5% in fiscal 2021,” the report said.
It said environmental considerations were also taken into account to formulate Pakistan’s credit profile, as the country is vulnerable to climate change. “While the agricultural sector accounts for around 20% of GDP and exports, it accounts for slightly over 40% of total employment. Overall, around 70% of the entire population lives in rural areas. As a result, both droughts and floods can create economic, fiscal and social costs for the sovereign,” it added.
The report said the rating could go up if ongoing fiscal reforms raised the government’s revenue base and debt affordability, and lowered its debt burden beyond current expectations. “Further reduction in external vulnerability risks, including through higher levels of foreign exchange reserve adequacy and/or increased economic competitiveness that were to lift export prospects, would also put upward pressure on the rating,” it added.
Alternately, the report said, renewed deterioration in Pakistan’s external position could bring it’s rating back down, as it could threaten the government’s external repayment capacity and heighten liquidity risks. “A continued rise in the government’s debt burden, without prospects for stabilization over the medium term, would also put downward pressure on the rating.”
Adviser to Prime Minister on Finance Abdul Hafeez Shaikh hailed the move on Twitter, saying the upgraded outlook was “affirmation of [the] Government’s success in stabilizing the country’s economy and laying a firm foundation for robust long term growth.”