Moody’s Investors Service has revised the outlook on Pakistan’s foreign currency government bond rating to positive from stable. The rating is affirmed at Caa1.
Concurrently, Moody’s has affirmed the government’s issuer rating and senior unsecured rating at Caa1. The Caa1 rating is also affirmed for US dollar Trust Certificates issued by The Second Pakistan International Sukuk Company Limited.
RATIONALE FOR THE POSITIVE OUTLOOK
Moody’s decision to revise the outlook on Pakistan’s foreign currency rating is based on a strengthening external liquidity position, continued efforts toward fiscal consolidation, and the government’s steady progress in achieving structural reforms under the IMF program.
First Driver – A stronger external liquidity position
Net foreign reserves with the State Bank of Pakistan climbed to $11.2 billion as of 13 March 2015, from $3.2 billion at the end of January 2014. The cushion provided by foreign reserves coupled with dwindling external debt repayments to the IMF has reduced external vulnerabilities. This has in large part resulted from a lower current account deficit, which was easily financed by the issuance of a Eurobond in April 2014, a Sukuk issuance in December, continued disbursements under the IMF program, and privatization proceeds.
The narrowing of the current account deficit to 1.2% of GDP in the fiscal year ended June 2014 (FY2014) from 2.1% in FY2012 was largely due to the steady uptick in workers’ remittances and receipt of anti-terrorism Coalition Support Funds from the US. We estimate that the current account will narrow further in fiscal 2015 to 0.8% of GDP, on account of the fall in oil prices.
Second driver – Efforts towards fiscal consolidation
Although wide fiscal deficits and high debt levels remain a credit constraint, Pakistan has made progress towards fiscal consolidation. In FY2014, the government was able to bring the deficit down to 5.5% of GDP (excluding grants), from 8.2% the previous year. The government is targeting a further shrinkage in the deficit, to 4.9% of GDP in FY2015. Although the pace of deficit reduction may be less marked than the budget forecasts suggest, we expect the authorities will continue along the path of fiscal consolidation.
The government has relied on the banking system for deficit financing, but such borrowing is gradually declining as privatization proceeds, and the Eurobond and Sukuk issuances, have helped it to diversify funding. Moreover, the maturity of domestic public debt is lengthening as the government substitutes shorter-term treasury bills with Pakistan Investment Bonds that carry a longer tenure. This will reduce roll-over risks and volatility in debt issuance prices.
Third Driver – Progress in achieving structural reforms and quantitative targets under the IMF program
Under its program with the IMF, Pakistan has also made steady progress on structural reforms. As of December 2014, it had cleared five program reviews, receiving $3.2 billion in financial assistance under the SDR 4.39 billion ($6.1 billion at current exchange rates) program that it signed in September 2013. In early February this year, the IMF issued a statement upon the conclusion of its Staff Mission, indicating that the sixth review had been conducted successfully and was being reviewed by the IMF’s Management Board.
Reform measures stipulated under the program primarily focus on fiscal consolidation, debt management, and addressing structural constraints in the energy sector. Authorities are striving to meet the remaining structural benchmarks scheduled for the year ahead. These include the passage of legislation to enhance independence of the central bank, steps to improve monetary transmission and debt management, and privatization and strategic stake sales of state-owned enterprises.
RATIONALE FOR AFFIRMING THE Caa1 RATING
Although Pakistan’s international liquidity buffer has been replenished and balance of payments pressures have subsided, an incipient recovery in investor confidence has not yet significantly boosted direct investment inflows. In addition, most of the build-up in official reserves has come from external borrowings, including draw downs from Pakistan’s IMF program. Moreover, Pakistan’s economic recovery faces structural challenges, and reform measures have not completely taken hold.
While a positive outlook suggests a diminution of the probability of default, the Caa1 rating reflects Pakistan’s structurally large fiscal imbalances, high debt servicing costs, dependence on foreign creditors and substantial refinancing needs. It also incorporates implementation risk associated with economic reform and a high susceptibility to event risk — both on the political front and in terms of economic vulnerabilities that could arise, primarily from Pakistan’s reliance on bilateral and multilateral support.
WHAT COULD MOVE THE RATING UP/DOWN
Upward triggers to the rating would stem from the further implementation of reforms or the successful completion of the IMF program, additional strengthening in the external liquidity position or continued fiscal consolidation. Sustained progress in structural reforms would remove infrastructure impediments and supply-side bottlenecks, improving Pakistan’s investment environment and eventually aiding a shift to a higher growth trajectory. Domestic political stability and steady relations with international donors would further support the rating.
Conversely, a stalling of the ongoing IMF program or the withdrawal of other multilateral and bilateral support, a deterioration in the external payments position or a more unstable political environment would be viewed as credit negative.
Pakistan’s long-term local currency bond and deposit country ceilings are maintained at B1, while the long-term foreign currency bond and deposit ceilings are maintained at B3 and Caa2 respectively. All short-term ceilings are at Not Prime. The local currency country ceiling refers to risks affecting a given country that arise from political, institutional, financial and economic factors either within the country or externally. These ceilings act as a cap on ratings that can be assigned to the foreign and local currency obligations of entities domiciled in the country.
GDP per capita (PPP basis, US$): 4,574 (2013 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 4.14% (2014 Provisional) (also known as GDP Growth)
Inflation Rate (CPI, % change Jun/Jun): 8.2% (2014 Actual)
Gen. Gov. Financial Balance/GDP: -5.5% (2014 Actual) (also known as Fiscal Balance, excluding grants)
Current Account Balance/GDP: -1.2% (2014 Actual) (also known as External Balance)
External debt/GDP: 24.25% (2014 Actual)
Level of economic development: Very Low level of economic resilience
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983; these events occurred in 1998 and 1999.
On 23 March 2015, a rating committee was called to discuss the rating of the Pakistan, Government of. The main points raised during the discussion were: The issuer’s fiscal or financial strength has materially increased. The issuer has become less susceptible to event risks.
The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this rating action, if applicable.