S&P Global Ratings on Monday lowered its long-term sovereign credit rating on Pakistan to ‘B-‘ from ‘B’. The outlook for the long-term rating is stable. At the same time, we affirmed the short-term sovereign rating and issue rating at ‘B’. The also lowered the long-term issue rating on senior unsecured debt and sukuk trust certificates to ‘B-‘ from ‘B’.
S&P in its report stated that the stable outlook reflects our expectations that Pakistan will secure sufficient financing to meet its external obligations over the next 12 months, and that neither external nor fiscal metrics will deteriorate well beyond our current projections.
Furthermore, the rating may raise on Pakistan if the economy materially outperforms on the expectations, strengthening the country’s fiscal and external positions.
Conversely, S&P may lower the ratings if Pakistan’s fiscal, economic, or external indicators continue to deteriorate, such that the government’s external debt repayments come under pressure. Indications of this would include GDP growth below our forecast, or external or fiscal imbalances higher than what S&P expected.
S&P in its report reasoned that lowering the ratings to reflect more subdued expectations for Pakistan’s economic growth, along with heightened external and fiscal risks, amid an ongoing deterioration in the country’s broad macroeconomic settings. While Pakistan has secured financial aid from bilateral partners to address its immediate external financing needs, we believe that fiscal and external imbalances will remain elevated. The government’s protracted negotiations with the International Monetary Fund (IMF) suggest that any resulting reforms, whether under the program or otherwise, will be less expedient than previously anticipated.
Fiscal consolidation will be challenging as the economy slows owing to a paucity of growth drivers, and as the stimulus from China-Pakistan Economic Corridor (CPEC) investment fades. Although we believe Pakistan will benefit over the long term from the associated improvements to its infrastructure, this will be counterbalanced by heightened fiscal and external stresses over the next few years.
S&P stated that the government led by Pakistan Tehreek-e-Insaf (PTI) party has yet to introduce fiscal measures that are sufficient to bring about a substantial improvement in the general government deficit.
Though the government in October 2018 introduced new budget measures that will increase revenue from petroleum products and infrastructure development, among others, S&P believes that additional measures would be necessary in order to bring about a more meaningful decline in the fiscal deficit.
The second mini-budget presented in January should be marginally supportive of the economy, but is unlikely to have a significant impact on fiscal imbalances. Relative to S&P’s previous expectations, we now believe prospects for a broader stabilization of Pakistan’s credit metrics have diminished.
The ratings on Pakistan remain constrained by a narrow tax base and domestic and external security risks, which continue to be high. Although the country’s security situation has gradually improved over the recent years, ongoing vulnerabilities weaken the government’s effectiveness and weigh on the business climate.
Institutional and economic profile: Change in government yet to yield serious reform push. Although Pakistan’s new government has publicly acknowledged the necessity of economic and fiscal reform, progress has been slower thaanticipated. Pakistan’s very low income level remains a rating weakness Inadequate infrastructure and security risks continue to act as structural impediments to foreign direct investment and sustainable economic growth.
The 2018 general elections have thus far not elicited a significant improvement in Pakistan’s economic environment. Despite acknowledgment by senior administration officials that Pakistan must embrace hard-hitting economic and fiscal reforms to avert a balance of payments and broader economic crisis, S&P believe that imbalances will remain elevated over the next two years. Although no single party earned a majority of the votes in July 2018’s general elections, the PTI’s leading vote share was sufficient to propel party chairman Imran Khan to the post of prime minister in the newly formed coalition government.
Pakistan is facing considerable external and fiscal pressure following a significant rise in both the general government fiscal and current account deficits in the fiscal year ended June 2018. These metrics have deteriorated since the completion of an Extended Funding Facility (EFF) reform program with the IMF in September 2016, leading the current government to seek financial and technical assistance from a variety of bilateral and multilateral parties. Against our previous expectations, we now believe that these difficulties will persist for some time, and that key metrics will worsen further through 2019.
In order to meet the economy’s elevated external funding needs, the government has reportedly secured foreign exchange support of approximately US$3 billion each from the United Arab Emirates (UAE) and Saudi Arabia, along with deferred payments of US$3.2 billion from each country for 2019 oil imports. These funds will help to alleviate acute external stresses and to supplement the central bank’s limited foreign exchange reserves.
Nevertheless, negotiations with the IMF for additional funding, potentially under the auspices of a new EFF program, have yet to deliver tangible results. The S&P estimate Pakistan’s GDP per capita at just over US$1,500 in 2018, which is in the bottom 10% of all sovereigns rated by S&P Global Ratings. The S&P have revised downward our forecast of annual real GDP growth to an average 3.6% over 2019-2022. Pakistan’s per capita GDP growth is somewhat lower, at about 1.5%, due to a fast-growing population. Our weaker growth projections mainly reflect the diminishing stimulatory impact of the investments associated with the CPEC, negative fiscal impulse as the government looks to rein in its deficit, and declining economic sentiment.
S&P in its report stated that CPEC energy projects such as coal, solar, hydroelectric, liquefied natural gas, and power transmission will be supportive toward economic activity over the long run, this effect is unlikely to sufficiently offset the loss in momentum in the economy during this period of acute fiscal and external stress.
Growth will also be constrained by domestic security challenges and long-lasting hostility with neighboring India and Afghanistan. These conditions, along with inadequate infrastructure, mainly in transportation and energy, are additional bottlenecks to foreign direct investments. The former PML government improved the security situation, and it is expected the PTI government to continue this positive momentum. Although progress has been made toward addressing these shortcomings, we believe there is much more to be done before we can see considerable uplift to the business climate.
Flexibility and performance profile: Deterioration in key metrics to continue through 2019 Infrastructure investments and energy vulnerabilities have contributed to a significant weakening in external metrics. Pressure on external accounts will rise further in 2019. The S&P forecast net general government debt to rise toward 70.2% of GDP by the end of fiscal 2022, with slower GDP growth and still-elevated deficits. Likewise, Pakistan’s interest-servicing burden will remain elevated, at an average of 32.4% of revenues.
Over the near term, deferred payments on oil imports from the UAE and Saudi Arabia, with an estimated total value of US$6.4 billion, will help to smooth pressing external financing needs. But more will need to be done to stem this vulnerability over the medium term, especially on export promotion and energy security.
Pakistan’s current account deficit widened again to 6.1% of GDP in the fiscal year ended June 2018, from 4.1% the year before and just 1.7% in 2016. The widening of the deficit was due to a strong rise in imports, without a correspondingly high growth in exports, with higher energy prices and the associated deterioration in Pakistan’s terms of trade exacerbating the shortfall in the current account deficit. Remittances were roughly flat for the second year in a row in 2018, exhibiting limited upside despite a stabilization in the Gulf countries.
Although the S&P expect the current account deficit to decline somewhat over the next two years with energy prices falling and the economy slowing, Pakistan’s external financing and indebtedness metrics remain stressed. Pakistan’s high degree of external stress is marked by a significant rise in the economy’s gross external financing needs relative to its current account receipts and useable reserves; The S&P forecast this ratio will climb to 151.1% at the end of fiscal 2019, versus approximately 131% in the previous year. Meanwhile, S&P project the country’s narrow net external debt will rise to more than 170% of current account receipts, from just below 140% in the prior year. Though external aid will help to meet immediate payment needs, indebtedness will continue to rise in kind.
Pakistan’s fiscal profile has deteriorated beyond our previous expectations, and the S&P have yet to observe policy initiatives sufficient to meaningfully reverse this trend. Change in net general government debt rose to 9.4% in fiscal 2018 versus 5.6% in the previous year, largely owing to the government’s higher fiscal deficit and the depreciation of the Pakistani rupee.
Although the new government has elucidated its aim to consolidate its fiscal accounts, S&P believe progress will be diminished by political constraints, especially in view of more difficult economic circumstances. Meanwhile, negotiations with the IMF to secure a funding and aid package have been protracted. The S&P anticipates that any resulting reforms, whether under a program or otherwise, will be less expedient in addressing the country’s economic imbalances. We forecast the average annual change in net general government debt at 5.9% of GDP through 2022, which is elevated versus S&P’s previous expectations.
Coupled with our lower expectations for real GDP growth, the forecast fiscal deficits will entail a gradual rise in net general government indebtedness toward just above 70% of GDP by the end of 2022.
Pakistan’s unusually high level of interest expense relative to fiscal revenue is an additional constraint on our assessment of the government’s debt burden.Interest expense consumes nearly a third of government revenue, partly a function of its narrow tax base.
Pakistan’s ratio of tax revenue to GDP remains one of the lowest among sovereigns that S&P rate. Pakistan’s banking system is relatively small by international standards, with total bank assets comprising approximately 59% of GDP. The S&P is its report stated that the rating agency do not have a Banking Industry Country Risk Assessment on Pakistan.
However, its banking system appears stable, reflecting its high profitability, adequate liquidity, and strong capitalization. Combining our view of Pakistan’s government-related entities and its financial system, S&P assess the country’s contingent fiscal risks as limited. That said, at more than 20% of total system assets, Pakistan’s banking system bears an outsized exposure to the sovereign.
S&P believes the State Bank of Pakistan’s (SBP) autonomy and performance has strengthened since the setup of a monetary policy committee for rate setting in January 2016. The SBP’s interest rate corridor helps the monetary transmission mechanism by providing directions for short-term market interest rates. This framework, combined with the cyclical boost from lower food and energy prices, should keep inflation in check–averaging about 5.5% over S&P’s forecast horizon. Reduced budget financing by the SBP would also assist in cutting inflationary pressure.