Pakistan’s Foreign-Currency Issuer Default Rating (IDR) has been upgraded by Fitch Ratings from ‘CCC-‘ to ‘CCC,’ signaling improved external liquidity and funding conditions, according to a statement issued Monday.
The upgrade comes after Pakistan’s Staff-Level Agreement (SLA) with the International Monetary Fund (IMF) on a nine-month Stand-by Arrangement (SBA) in June. The SLA is expected to be approved by the IMF board in July, paving the way for additional funding and policies aligned with parliamentary elections scheduled for October. However, risks persist due to a volatile political climate and a significant external financing requirement.
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In recent months, Pakistan has taken steps to address issues such as government revenue shortfalls, energy subsidies, and policies inconsistent with a market-determined exchange rate. These actions were necessary to overcome hurdles that hindered the completion of the last three reviews of Pakistan’s previous IMF program, which expired in June. The government has also made amendments to its proposed budget for the fiscal year ending in June 2024, introducing new revenue measures and reducing spending.
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Despite these positive developments, there are concerns about the implementation of the SLA and external funding risks, particularly given the upcoming elections and uncertainties surrounding post-election commitments to the program. The approval of the SBA by the IMF board will unlock an immediate disbursement of USD1.2 billion, with the remaining USD1.8 billion scheduled for release after reviews in November and February 2024. Saudi Arabia and the United Arab Emirates have committed an additional USD3 billion in deposits, and the authorities anticipate USD3-5 billion in new multilateral funding following the IMF agreement.
To meet its funding targets, Pakistan aims to secure USD25 billion in gross new external financing in FY24, while facing USD15 billion in public debt maturities. This includes USD1 billion in bonds and USD3.6 billion to multilateral creditors. The government plans to raise USD1.5 billion through market issuance and USD4.5 billion through commercial bank borrowing, which may pose challenges. However, the possibility of loans not rolled over in FY23 returning could mitigate these challenges. Additionally, maturing deposits from China, Saudi Arabia, and the UAE, totaling USD9 billion, are likely to be rolled over, similar to the previous fiscal year.
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Pakistan’s current account deficit (CAD) has significantly narrowed, driven by import restrictions, tighter fiscal and economic policies, measures to limit energy consumption, and lower commodity prices. The country achieved current account surpluses from March to May 2023, and it is projected to maintain a CAD of approximately USD4 billion (1% of GDP) in FY24. This is a decline from USD3 billion in FY23 and over USD17 billion in FY22. However, the CAD could widen beyond expectations due to reports of import backlogs, reliance on foreign inputs by the manufacturing sector, and reconstruction needs following last year’s floods. Currency depreciation may help limit the rise, as the authorities intend to finance imports through banks rather than official reserves. Furthermore, remittance inflows could recover as they partially shift back to official channels with more favorable parallel market exchange rates.
In addition to the upgrade of Pakistan’s IDR, Fitch Ratings also considers other factors in its assessment. Liquid net foreign exchange reserves of the State Bank of Pakistan remain low at around USD4 billion, which is less than a month’s worth of imports. This decline from the peak of over USD20 billion in August 2021 is attributed to large current account deficits, external debt servicing, and previous foreign exchange interventions by the central bank. Although a modest recovery is expected for the rest of FY24 due to new external financing flows, this could lead to a renewed widening of the CAD.
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Pakistan’s political landscape is marked by volatility, with protests by supporters of former prime minister Imran Khan and his PTI party intensifying in May. While the enduring popularity of Mr. Khan and PTI creates uncertainty surrounding elections, the fiscal deficit is expected to widen to 7.6% of GDP in FY24, driven by higher interest costs on domestic debt. The debt-to-GDP ratio of 74% at the end of FY23 is comparable to that of other ‘B,’ ‘C,’ and ‘D’ rated sovereigns. However, debt/revenue and interest/revenue ratios are considerably higher than those of peer countries, indicating a challenge in debt management.
Overall, the upgrade in Pakistan’s Long-Term Foreign-Currency IDR reflects improved external liquidity and funding conditions following the SLA with the IMF. However, risks associated with program implementation, political volatility, and external financing requirements remain. The approval of the SBA by the IMF board is expected to unlock significant funding and facilitate the disbursement of aid pledged at the flood relief conference. Pakistan will continue to navigate challenges in meeting its funding targets and managing its fiscal and external balances in the coming months.
