Singapore, June 02, 2022 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Pakistan's B3 local and foreign currency issuer and senior unsecured debt ratings, the (P)B3 senior unsecured MTN programme rating, and changed the outlook to negative from stable. The decision to change the outlook to negative is driven by Pakistan's heightened external vulnerability risk and uncertainty around the sovereign's ability to secure additional external financing to meet its needs. Moody's assesses that Pakistan's external vulnerability risk has been amplified by rising inflation, which puts downward pressure on the current account, the currency and – already thin – foreign exchange reserves, especially in the context of heightened political and social risk. Pakistan's weak institutions and governance strength adds uncertainty around the future direction of macroeconomic policy, including whether the country will complete the current IMF Extended Fund Facility (EFF) program and maintain a credible policy path that supports further financing.
The decision to affirm the B3 rating reflects Moody's assumption that, notwithstanding the downside risks mentioned above, Pakistan will conclude the seventh review under the IMF EFF programme by the second half of this calendar year, and will maintain its engagement with the IMF, leading to additional financing from other bilateral and multilateral partners. In this case, Moody's assesses that Pakistan will be able to close its financing gap for the next couple of years. The B3 rating also incorporates Moody's assessment of the scale of Pakistan's economy and robust growth potential, which will provide the economy with some capacity to absorb shocks. These credit strengths are balanced against Pakistan's fragile external payments position, weak governance and very weak fiscal strength, including very weak debt affordability.
The B3 rating affirmation also applies to the backed foreign currency senior unsecured ratings for The Third Pakistan International Sukuk Co Ltd and The Pakistan Global Sukuk Programme Co Ltd. The associated payment obligations are, in Moody's view, direct obligations of the Government of Pakistan.
Concurrent to today's action, Pakistan's local and foreign currency country ceilings have been lowered to B1 and B3, from Ba3 and B2, respectively. The two-notch gap between the local currency ceiling and sovereign rating is driven by the government's relatively large footprint in the economy, weak institutions, and relatively high political and external vulnerability risk. The two-notch gap between the foreign currency ceiling and the local currency ceiling reflects incomplete capital account convertibility and relatively weak policy effectiveness, which point to material transfer and convertibility risks notwithstanding moderate external debt.
RATINGS RATIONALE
RATIONALE FOR THE CHANGE IN OUTLOOK TO NEGATIVE FROM STABLE
HIGHER EXTERNAL VULNERABILITY RISK TO PERSIST DUE TO UNCERTAINTY AROUND ADDITIONAL EXTERNAL FINANCING
Moody's expects Pakistan's current account to remain under significant pressure, on the back of elevated global commodity prices through 2022 and 2023. Pakistan's current account deficit has widened to a cumulative $13.8 billion since the start of the current fiscal year in July 2021 up until April 2022, compared to a deficit of $543 million in the same period a year earlier. In the absence of an equivalent inflow in the financial account, the rapid widening of the current account deficit has led to a large drawdown of the foreign exchange reserves. According to data from the IMF, Pakistan's foreign exchange reserves have declined to $9.7 billion at the end of April 2022, which is sufficient to cover less than two months of imports. This compares with the $18.9 billion of reserves at the end of July 2021.
Moody's projects the current account deficit to come in at 4.5-5% of GDP for fiscal 2022 (ending June 2022), slightly wider than the government's expectations. As global commodity prices decline gradually in 2023 and as domestic demand moderates, Moody's expects the current account deficit to narrow to 3.5-4% of GDP. Moody's current account deficit forecasts are higher than previous (early February 2022) projections of 4% and 3% for fiscal 2022 and 2023, respectively.
The larger current account deficits underscore the need for Pakistan to secure additional external financing, especially given its very low foreign exchange reserves. Pakistan is in negotiations with the IMF on the seventh review of the EFF programme. Moody's expects Pakistan to successfully conclude the review by the second half of the year, with the associated IMF financing to be disbursed then. Conclusion of the seventh review, and further engagement with the IMF, will also help Pakistan secure financing from other bilateral and multilateral partners. In this scenario, Moody's expects Pakistan to be able to fully meet its external obligations for the next couple of years.
However, Moody's assesses that the balance of risks is on the downside. An agreement with IMF could take longer than expected, as the government may find it difficult to reduce fuel and power subsidies given rising inflation. Recent moves by the government to raise fuel prices signal its commitment to addressing issues raised by the IMF. Still, political and social challenges will complicate the government's efforts to agree on and implement further reforms, such as revenue raising reforms. While not Moody's baseline scenario, if Pakistan is unable to secure additional financing later this year, foreign exchange reserves will continue to be drawn down from already very low levels, increasing the risk of a balance of payments crisis.
HEIGHTENED POLITICAL RISK CHALLENGES THE STABILITY AND PREDICTABILITY OF POLICYMAKING
As mentioned above, Pakistan's rising external vulnerability risk has been amplified by rising inflation, particularly in the context of heightened political and social risks. In April 2022, inflation reached 13.4% year-on-year, with particularly high inflation in food and energy which account for a very large share of the most vulnerable households' budgets.
Moody's assesses that political uncertainty in Pakistan remains high, even after the new government has been installed. The new ruling coalition comprises of multiple political parties with divergent interests, which is likely to make the enactment of any legislation difficult, including those related to reforms under the IMF EFF programme. Moreover, the next elections are due by the middle of 2023. In Moody's view, political parties will find it difficult to continually enact significant revenue-raising measures in the run-up to the elections, especially in a high inflation environment.
Rising interest rates are also likely to increasingly constrain the government's policy choices, especially since interest payments already absorb more than 40% of revenue.
Meanwhile, domestic political risk has also risen with a higher frequency of terrorist attacks over the last year. According to the Pak Institute for Peace Studies think-tank, the number of terrorist attacks increase 42% in 2021 compared to a year ago. More frequent terrorist attacks add to safety concerns, which may increase social risks, as well as constrain business conditions and limit investment.
Moody's assesses that there is a material probability of a recurrence in domestic political stress that will impinge on the effectiveness of policymaking and the government's ability to implement timely economic reforms aimed at achieving macroeconomic stability.
RATIONALE FOR THE AFFRIMATION OF THE B3 RATING
The affirmation of the B3 rating reflects Moody's assumption that Pakistan will secure external financing, including through the conclusion of the seventh review and subsequent reviews under the IMF EFF programme and avoid a balance of payment crisis.
Pakistan's B3 rating also reflects Moody's assessment that the country's large size and robust potential growth provides it with some capacity to absorb economic shocks. Pakistan's potential growth of about 5% in part reflects the country's favourable demographics with its sizable under-30 population. Nonetheless, Pakistan's potential growth is constrained by structural challenges, including weak governance and weak competitiveness.
Pakistan, like many of its South Asian neighbours, is vulnerable to environmental risks. Pakistan drains a significant portion of its scarce fresh water resources every year and has a large share of its population exposed to unsafe drinking water. The country is also exposed to extreme weather events, such as heat waves and floods, which can create negative economic and social costs.
Moody's projects Pakistan's real GDP growth to slow to 4.2% in fiscal 2023, moderately lower than the government's projections. This compares with growth of 6.0% in fiscal 2022. The moderation in economic activity reflects the drag on domestic demand from rising inflation and a tightening in monetary policy by the State Bank of Pakistan. Moody's expects Pakistan's real GDP to pick up gradually reaching 4.5-5% over fiscal 2024 and 2025.
Meanwhile, Pakistan's fiscal strength is very weak, a long-standing feature of the sovereign's credit profile. Moody's expects fiscal consolidation to stall ahead of the next general elections. Moody's projects Pakistan's government debt to stabilise at around 70% of GDP for fiscal 2022 and 2023, higher than the median of 63% for B-rated sovereigns. Meanwhile, given a very narrow revenue base, Pakistan's government debt as a share of revenue is very high at around 560% in fiscal 2021. Moody's expects this ratio to remain elevated at 550-590% over fiscal 2022 to 2024, well above the 290% for the median B-rated sovereign. As mentioned, the sovereign also has very weak debt affordability – one of the weakest among Moody's rated sovereigns.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
Pakistan's ESG credit impact score is Highly Negative (CIS-4), reflecting its high exposure to environmental and social risks, as well as its weak governance profile. Relatively weak institutions and very weak fiscal strength constrain the government's capacity to address ESG risks.
Exposure to environmental risk is Highly Negative (E-4 issuer profile score) because of Pakistan's vulnerability to climate change and the limited supply of clean, fresh and safe water. Pakistan drains a significant proportion of its scarce fresh water resources every year, and a large share of its population is exposed to unsafe drinking water. Water utility services tend to be intermittent, because of high leakage levels, limited supply and insufficient access to power. The inadequate quality of drinking water has health and economic consequences for Pakistan, such as contributing to stunting which undermines human capital. With varied climates across the nation, Pakistan is significantly exposed to extreme weather events, including tropical cyclones, drought, floods and extreme temperatures. In particular, the magnitude and dispersion of seasonal monsoon rainfall influence agricultural sector growth and rural household consumption. Agriculture accounts for around 20% of GDP and exports, and nearly 40% of total employment. Overall, around 70% of the entire population live in rural areas. As a result, both droughts and floods can create economic, fiscal and social costs for the sovereign.
Exposure to social risk is Highly Negative (S-4 issuer profile score), driven by safety concerns that have limited investment and diversification opportunities. Very low incomes as well as limited access to quality healthcare, basic services, housing and education, especially in rural areas, are also important social issues. In addition, rising inflation has also led to higher social tensions as cost of living increases. That said, the government has taken steps to reduce poverty and inequality, strengthening social safety nets, and promoting human capital as key priorities through its expansive 'Ehsaas' programme (national poverty alleviation programme), although effects will take time to materialise and are limited by still weak institutions and governance.
Pakistan's governance risk exposure is Highly Negative (G-4 issuer profile score). International surveys of various indicators of governance, while showing some early signs of improvement, continue to point to weak rule of law and control of corruption, as well as limited government effectiveness. The score also takes into account Pakistan's efforts in improving its macroeconomic policy effectiveness in recent years. For example, the government has amended the State Bank of Pakistan Act to strengthen the independence of the central bank and restrict the central bank from extending credit to the government.
GDP per capita (PPP basis, US$): 5,541 (2020 Actual) (also known as Per Capita Income)
Real GDP growth (% change): -0.9% (2020 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 8.6% (2020 Actual)
Gen. Gov. Financial Balance/GDP: -7% (2020 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -1.5% (2020 Actual) (also known as External Balance)
External debt/GDP: 37.6% (2020 Actual)
Economic resiliency: ba2
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 30 May 2022, a rating committee was called to discuss the rating of Pakistan, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer has become increasingly susceptible to event risks.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
FACTORS THAT COULD LEAD TO AN UPGRADE
The negative outlook signals that a rating upgrade is unlikely over the near term. The outlook would likely be changed to stable if Pakistan's external vulnerability risks decreased materially and durably. This could come from access to material external financing that significantly raises foreign exchange reserves, potentially upon successful completion of the current IMF External Fund Facility programme, with credible commitment from the government to follow through the implementation of economic reforms. A resumption of fiscal consolidation, including through implementing revenue-raising measures, pointing to a meaningful improvement in debt affordability would also be credit positive.
FACTORS THAT COULD LEAD TO A DOWNGRADE
The rating would likely be downgraded if there were a further deterioration in Pakistan's external position that would threaten the government's external repayment capacity and balance of payments stability. This could come from protracted negotiations with the IMF, resulting in delays in securing additional financing from IMF or other sources beyond this year. Expectations that the government debt would rise markedly, with a related deterioration in debt affordability from already weak level, would also put downward pressure on the rating. Finally, an increase in social and political risk that disrupted policymaking and undermined Pakistan's ability to secure financing would also be negative for the rating.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
REGULATORY DISCLOSURES
The List of Affected Credit Ratings announced here are a mix of solicited and unsolicited credit ratings. For additional information, please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com. Additionally, the List of Affected Credit Ratings includes additional disclosures that vary with regard to some of the ratings. Please click on this link https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL466304 for the List of Affected Credit Ratings. This list is an integral part of this Press Release and provides, for each of the credit ratings covered, Moody's disclosures on the following items:
• Rating Solicitation
• Issuer Participation
• Participation: Access to Management
• Participation: Access to Internal Documents
• Endorsement
• Lead Analyst
• Releasing Office
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the issuer/deal page for the respective issuer on https://ratings.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
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