ISLAMABAD: Raising questions over economic fundamentals over the next two years, Standard & Poor’s on Monday downgraded Pakistan’s long-term credit rating to ‘B-Negative’ from ‘B’, as the new government struggled with structural reform push.

“Pakistan’s economic outlook, as well as its external position, have deteriorated well beyond our previous expectations,” said the New York-based rating agency, adding that it also lowered the long-term issue rating on senior unsecured debt and Sukuk bond to ‘B-’ from ‘B’.

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With weaker economic settings and limited progress in addressing fiscal imbalances following the elections in mid-2018, the rating agency said: “The prospects for a rapid recovery in fiscal and external settings are now diminished.”

More modest growth prospects and limited reserve buffers will continue to challenge the country’s external position, even as the government receives financial aid from various partners. Negotia­tions with the International Monetary Fund had taken longer than anticipated, the S&P said, believing that the reform timeline would be more protracted in nature.

Says prospects for rapid recovery in fiscal, external settings now diminished

In the short-term, the agency affirmed Pakistan’s ‘B’ rating on the basis of expectations that the country would secure sufficient funding to meet its external obligations in the next one year and that neither external nor fiscal metrics would deteriorate well beyond current projections.

“We may raise our ratings on Pakistan if the economy materially outperforms our expectations, strengthening the country’s fiscal and external positions,” the agency said, but warned that ratings could be lowered further if Pakistan’s fiscal, economic or external indicators continued to deteriorate, such that the government’s external debt repayments came under pressure.

The S&P said the GDP growth rate would fall to four per cent this year (2019) from 5.8pc last year (2018) and then stay 3.5pc for the next two years (2020 and 2021) and fall further to 3.3pc by 2022.

It noted that Pakistan had secured financial aid from bilateral partners to address its immediate external financing needs, but fiscal and external imbalances would remain elevated. The government’s protracted negotiations with the IMF suggest that any resulting reforms, whether under the programme or otherwise, will be less expedient than previously anticipated.

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Fiscal consolidation will be challenging as the economy slows owing to a paucity of growth drivers, and as the stimulus from China-Pakistan Economic Corridor (CPEC) investment fades. Although Pakistan will benefit over the long term from the associated improvements in its infrastructure, this will be counterbalanced by heightened fiscal and external stresses over the next few years.

“In our opinion, the government led by Pakistan Tehreek-i-Insaf (PTI) party has yet to introduce fiscal measures that are sufficient to bring about a substantial improvement in the general government deficit,” the S&P noted. It expressed concern over the measures taken in the October 2018 mini-budget to increase revenue from petroleum products and infrastructure development and said additional measures would be necessary to bring about a more meaningful decline in the fiscal deficit.

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The second mini-budget presented in January should be marginally supportive of the economy, but is unlikely to have a significant impact on fiscal imbalances.

The ratings on Pakistan remain constrained by a narrow tax base and domestic and external security risks, which continue to be high. Although the country’s security situation has gradually improved over the recent years, the ongoing vulnerabilities weaken the government’s effectiveness and weigh on the business climate. Moreover, the change in government after the elections failed to yield serious reform push on institutional and economic profile even though it publicly acknowledged the necessity of economic and fiscal reform. “Progress has been slower than anticipated,” the rating agency said.

On top of that, the country’s very low income level remained a rating weakness and inadequate infrastructure and security risks continued to act as structural impediments to foreign direct investment and sustainable economic growth. “The 2018 general elections have thus far not elicited a significant improvement in Pakistan’s economic environment and these difficulties would persist for some time, and key metrics will worsen further through 2019,” the S&P said.

The agency estimated Pakistan’s GDP per capita at just over $1,500 in 2018, one of the lowest, and forecast annual real GDP growth to an average 3.6pc over 2019-22. Pakistan’s per capita GDP growth is somewhat lower, at about 1.5pc, due to a fast-growing population.

“Our weaker growth projections mainly reflect the diminishing stimulatory impact of the investments associated with the CPEC, negative fiscal impulse as the government looks to rein in its deficit, and declining economic sentiment. Growth will also be constrained by domestic security challenges and long-lasting hostility with neighbouring India and Afghanistan,” it added.

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The S&P said the previous Pakistan Muslim League-Nawaz government had improved the security situation, and “we would expect the PTI government to continue this positive momentum to improve business climate”.

It said the pressure on external accounts would increase further in 2019 and general government debt was forecast to rise toward 70.2pc of GDP by the end of fiscal 2022, with slower GDP growth and still-elevated deficits. Likewise, Pakistan’s interest-servicing burden will remain elevated, at an average of 32.4pc of revenues.

The rating agency expected the current account deficit to decline somewhat over the next two years, with energy prices falling and the economy slowing, but Pakistan’s external financing and indebtedness metrics remained stressed. The country’s high degree of external stress is marked by a significant rise in the economy’s gross external financing needs relative to its current account receipts and useable reserves. “We forecast this ratio will climb to 151.1pc at the end of fiscal 2019, versus approximately 131pc in the previous year,” it said.

The S&P also projected the country’s narrow net external debt to rise to more than 170pc of current account receipts from just below 140pc the previous year. Though external aid will help meet immediate payment needs, indebtedness will continue to rise in kind. Although the new government has elucidated its aim to consolidate its fiscal accounts, the rating agency believed the progress would be diminished by political constraints, especially in view of more difficult economic circumstances.

Published in Dawn, February 5th, 2019