ISLAMABAD - Moody’s Investors Service has changed Pakistan’s outlook to stable from negative as the country’s balance of payments dynamics continues to improve.

The international credit agency on Monday also affirmed the Government of Pakistan’s local and foreign currency long-term issuer and senior unsecured debt ratings at B3.

The Ministry of Finance welcomed the upgrade terming it “an affirmation of the government’s success in handling the country’s economy”.

The changing of country’s economic 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 in a detailed statement.

The New York-based agency further said that such developments reduce external vulnerability risks, although foreign exchange reserve buffers remain low and will take time to rebuild.

Though fiscal strength has weakened with higher debt levels, largely as a result of currency depreciation, ongoing fiscal reforms, including those being carried out through the International Monetary Fund (IMF) programme, will mitigate risks related to debt sustainability and government liquidity.

GDP growth expected to slow down to 2.9pc in fiscal 2020 before rising to 3.5pc in 2021

The rating affirmation reflects Pakistan’s relatively large economy and robust long-term growth potential, coupled with ongoing institutional enhancements that raise policy credibility and effectiveness, albeit from a low starting point, Moody’s said.

These credit strengths are balanced against structural constraints to economic and export competitiveness, the government’s low revenue generation capacity that weakens debt affordability, fiscal strength that will remain weak over the foreseeable future, as well as political and still-material external vulnerability risks.

Concurrently, Moody’s has affirmed the B3 foreign currency senior unsecured ratings for The Second Pakistan Int’l Sukuk Co. Ltd. and The Third Pakistan International Sukuk Co Ltd. 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.

Moody’s expects Pakistan’s current account deficit to continue narrowing in the current and next fiscal year. The current account deficit would remain at 2.2 percent of GDP as against 5 percent in the last fiscal year.  The deficit would narrow due to reduction in growth in imports. 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.

Moody’s expects exports to gradually pick up on the back of the real exchange rate depreciation over the past 18 months, also contributing to narrower current account deficits. The government is focusing on raising the country’s trade competitiveness and has recently rolled out a National Tariff Policy aimed at incentivising production for exports or import substitution. If effective, the policy, coupled with improvements in the terms of trade, will allow exports to grow more robustly.

Moody’s expects policy enhancements, including strengthened central bank independence and the commitment to currency flexibility, to support the reduction in external vulnerability risks. In particular, the government is planning to introduce a new State Bank of Pakistan (SBP) Act to forbid central bank financing of government debt and clarify SBP’s primary objective of price stability.

The central bank has already stopped purchases of government debt in practice since the start of fiscal 2020. At the same time, it has strongly adhered to its commitment to a floating exchange rate regime since May 2019. These enhancements to the policy framework will foster confidence in the Pakistani rupee, while the use of the exchange rate as a shock absorber increases policy buffers.

Notwithstanding improved balance of payments dynamics, Pakistan’s foreign exchange reserve adequacy remains low. Foreign exchange reserves have fluctuated around $7-8 billion over the past few months, sufficient to cover just 2-2.5 months of goods imports. Coverage of external debt due also remains low, with the country’s External Vulnerability Indicator -- which measures the ratio of external debt due over the next fiscal year to foreign exchange reserves -- remaining around 160-180%.

The IMF programme, which commenced in July 2019, targets higher foreign exchange reserve levels and has unlocked significant external funding from multilateral partners including the Asian Development Bank and the World Bank. Nevertheless, unless the government can effectively mobilise private sector resources, foreign exchange reserves are unlikely to increase substantially from current levels.

On the fiscal side, Pakistan’s metrics have weakened recently, with wider fiscal deficits and an increase in government debt burden largely as a result of currency depreciation over the course of fiscal 2019. However, Moody’s expects ongoing fiscal reforms, anchored by the IMF programme and technical assistance from other development partners, to contribute to a gradual narrowing of fiscal deficits. The reforms would also mitigate debt sustainability and government liquidity risks.

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. Meanwhile, government revenue as a share of GDP, while likely to increase, is growing from a lower base, having declined significantly in fiscal 2019.

To widen the tax net, the fiscal authorities have eliminated a number of tax exemptions and concessions and lowered the minimum threshold for personal income taxes. The authorities are also introducing automatic income tax filing to reduce tax evasion and applying the sales tax to a wider group of businesses. Support from the IMF and the World Bank will raise effectiveness of the revenue measures. However, Moody’s estimates that the revenue growth targets set by the IMF programme are 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.

On the expenditure side, the government has introduced a new Public Financial Management (PFM) Act, which was approved in June 2019, to instill budget discipline. The PFM Act notably bars the use of supplementary budgets except in exceptional circumstances, introduces the use of a single Treasury account to better monitor cashflows, and prevents fiscal authorities from changing future tax policies without parliamentary approval. The Act is in line with IMF recommendations and serves as primary legislation that will be accompanied by other secondary legislation to increase fiscal policy effectiveness.

Given baseline assumptions of gradually narrowing fiscal deficits, Moody’s expects the government’s general government debt to slowly decline over the next few years to around 75-76% of GDP by 2023, still a high debt burden, from a peak of around 82-83% of GDP currently. Moody’s projections are based on the assumption of relative exchange rate stability, particularly in comparison with the sharp exchange depreciation experienced between December 2017 and June 2019.



Govt reaction

PM Adviser on Finance Abdul Hafeez Shaikh said in a tweet that the “upgradation of outlook to Stable is affirmation of Government’s success in stabilising the country’s economy and laying a firm foundation for robust long term growth”.

The Finance Ministry also issued a statement welcoming the development and saying that “the government remains fully committed to its reform agenda, which is producing the outcomes that will lay a firm foundation for accelerated, sustainable and inclusive growth in the future.”

The upgradation “reflects Pakistan’s relatively large economy and robust long-term growth potential, coupled with ongoing institutional enhancements that raise policy credibility and effectiveness”, it said.

Moody’s also highlighted “Pakistan’s progress towards macroeconomic stabilisation with reduced vulnerabilities on the external account”, the ministry said.