ISLAMABAD-Fitch Ratings has affirmed Pakistan’s long-term foreign-currency Issuer Default Rating (IDR) at ‘B-’ with a Stable Outlook. Pakistan’s ‘B-’ rating reflects weak public finances, including large fiscal deficits and a high government debt/GDP ratio, a challenging external position characterised by large external debt repayments against low foreign-exchange reserves and low governance indicator scores. 

The coronavirus pandemic has exacerbated these challenges by depressing economic growth and pressuring the public finances. The external finances appear resilient to the shock due to the authorities’ policy actions and continuing multilateral and bilateral financial support.

Policy actions by the authorities over the past couple of years eased external vulnerabilities prior to the coronavirus shock. These included tighter monetary policy settings and the move to a more market-determined exchange rate regime, which contributed to a sharp narrowing of the current account deficit and a modest rebuilding of foreign-exchange reserves. 

Greater exchange rate flexibility has continued during the pandemic and has been an important shock absorber. Liquid gross foreign-exchange reserves rose to about $12.5 billion by end-July from $7.7 billion a year prior. 

A sharp reversal in March of record non-resident inflows to local-currency government notes (reaching a stock of $3.2 billion in February) generated exchange rate volatility and a modest decline in foreign-exchange reserves. Foreign holdings have stabilised since then, and reserves have been restored through multilateral and bilateral disbursements. The central bank’s net forward position has increased somewhat in the past months and net reserves remain negative, even though they have narrowed. Fitch forecasts a further rise in liquid gross reserves to about $16 billion by end of fiscal year ending June 2021 (FY21).

Pakistan’s current account deficit narrowed to 1.1 per cent of GDP in FY20, from a peak of 6.1 per cent in FY18, due mainly to import compression and lower oil prices. Fitch forecasts a slight widening of the current account deficit to 1.7 per cent in FY21 due to a modest recovery in imports and declining remittances.

 Remittances rose unexpectedly by 7.3 per cent in 4Q-FY20, but Fitch view this as temporary and expect a decline of about 10 per cent in FY21 due to the impact of the global economic shock on Pakistan’s overseas workers. External financing requirements have declined, in line with the narrowing of the current account deficit. However, the government’s external debt repayments remain high at about $10.3 billion (about 80 per cent of current gross liquid reserves) in FY21 and $8.9 billion in FY22. The $3 billion in deposits at the central bank from Saudi Arabia were slated to be rolled over through 2022, but the Saudi authorities requested repayment on $1 billion of the deposits in July. In baseline scenario, Fitch assume the additional $2 billion will be rolled over when the respective tranches mature in December and January, but this is subject to some risk.

Pakistan has received approval for its participation in the G-20’s Debt Service Suspension Initiative (DSSI), which will lower FY21 debt repayments to bilateral creditors by roughly $2 billion. The relief provided by bilateral creditors does not constitute a default under Fitch’s definitions, and Fitch understand that the authorities have ruled out any request for participation by private creditors. Access to external financing appears sufficient in the near-term to close any financing gap, underpinned by support from multilateral and bilateral creditors. 

In April, the IMF board approved $1.4 billion in financing through its Rapid Financing Instrument. The 39-month, $6 billion IMF programme, which began in July 2019, remains in place. Fitch expect the second review to be completed in the coming months, although it has been delayed since March, due mainly to the IMF’s willingness to facilitate the authorities’ policy focus on the coronavirus response. 

Fitch understand that both the IMF and government of Pakistan remain committed to the programme, which has facilitated significant financing from a range of multilateral institutions. Official bilateral and commercial bank borrowing from China has also been a key source of financing. The authorities have also indicated they plan to return to the international bond market later this calendar year. Public finances are a rating weakness. Fiscal consolidation efforts were affected by the coronavirus shock, but the general government fiscal deficit still declined to 8.1 per cent of GDP in FY20 from 9.1 per cent in FY19. 

The shock weighed on revenue in 4QFY20, but it still increased 28 per cent for the full year due in large part to base effects from low revenue collection during FY19 and the authorities’ earlier efforts to improve revenue collection. The government passed a PKR1.2 trillion (2.9 per cent of GDP) coronavirus support package in March to lift health spending and provide assistance to low-income households, although delayed disbursements limited the impact on the FY20 deficit. Limited headroom due to a large fiscal deficit, low revenue and high debt is likely to constrain further fiscal stimulus beyond the March package.Fitch forecast the fiscal deficit to remain roughly stable at 8.2 per cent in FY21, due to the lingering impacts of the coronavirus shock. Under the recently passed FY21 budget, the government targets a deficit of 7.0 per cent, but, in Fitch’s view, this target relies on optimistic revenue growth assumptions from ongoing administrative initiatives, as the budget does not contain new revenue raising measures. Fitch forecasts that Pakistan’s debt/GDP ratio will rise to about 90 per cent at FYE21, from 87.2 per cent at FYE20, well above the ‘B’ median of 50.8 per cent, increasing debt sustainability concerns. 

The deterioration in the debt/GDP ratio is much more significant than our expectation of an 80 per cent level by FYE20 at our last review in January, due to the coronavirus shock, as well as further currency depreciation. Under Fitch’s baseline the debt ratio will begin a gradual decline in FY22, to about 85 per cent of GDP by FYE25, as the fiscal deficit narrows and GDP growth picks up.

Fitch forecast GDP growth to rebound to 1.2 per cent in FY21, following a contraction of 0.4 per cent in FY20 resulting from the pandemic and the authorities’ macro adjustment policies. Risks to the forecasts are skewed to the downside given uncertainty around the coronavirus. 

Recent data show the spread of the virus to be declining, and the government appears keen to avoid re-imposition of widespread lockdown measures, opting instead for a “smart lockdown” strategy of targeting coronavirus hotspots. Recent locust infestations pose another downside risk to agriculture, and to the broader growth and the inflation outlook.