ISLAMABAD: Moody’s Investors Service on Tuesday downgraded Pakistan’s local and foreign currency issuer and senior unsecured debt ratings by two notches to Caa3 from Caa1 but improved the outlook to stable from negative.

The international rating agency – one of the top three global rating firms – said its decision to downgrade the ratings is driven by an assessment that Pakistan’s increasingly fragile liquidity and external position significantly raises default risks to a level consistent with a Caa3 rating.

In particular, the country’s foreign exchange reserves have fallen to extremely low levels, far lower than necessary to cover its import needs and external debt obligations over the immediate and medium term. Significant external financing becoming available in the very near term, such as through the disbursement of the next tranches under the current IMF programme and related financing, would reduce default risk potentially to a level consistent with a higher rating.

The rating agency said its downgrade to Caa3 from Caa1 rating also applied to the backed foreign currency senior unsecured ratings for the Pakistan Global Sukuk Programme Co Ltd. The associated payment obligations are, in Moody’s view, direct obligations of the Government of Pakistan.

Moody’s also lowered Pakistan’s local and foreign currency country ceilings to Caa1 and Caa3 from B2 and Caa1, respectively.

Warns of high default risks, but improves outlook if a deal is reached with IMF

Pakistan’s foreign exchange reserves have declined to a critically low level, sufficient to cover less than one month of imports. Amid delays in securing official sector funding, risks that Pakistan may not be able to source enough financing to meet its needs for the rest of FY23 have increased.

Beyond this fiscal year, liquidity and external vulnerability risks will continue to be elevated, as Pakistan’s financing needs will remain significant and financing sources are far from secure. At the same time, prospects of the country materially increasing its foreign exchange reserves are low.

Overall, Moody’s estimated that Pakistan’s external financing needs for the rest of the fiscal year ending June 2023 to be around $11bn, including the outstanding $7bn external debt payments due. The remainder includes the current account deficit, taking into account a sharp narrowing as imports have contracted markedly.

To meet these financing needs, Pakistan will need to secure financing from the IMF and other multilateral and bilateral partners. Despite recent delays, Moody’s assumes successful completion of the ninth review of the existing IMF programme, although this is not secured yet. This would in turn catalyse financing from other multilateral and bilateral partners.

At the same time, the government will also need to obtain the rollover of the $3bn China SAFE deposits and secure $3.3bn worth of refinancing from Chinese commercial banks for the rest of this fiscal year.

Of this $3.3bn, Pakistan has already received a deposit of $700 million from the China Development Bank on Feb 24.

While this year’s external payment needs may be met, the liquidity and external position next year will remain extremely fragile. Pakistan’s external debt repayments will remain high for the next few years.

Moody’s estimated Pakistan’s external financing needs for fiscal 2024 at around $35-36bn. Pakistan has about $25-26bn worth of external debt repayments (including interest payments) to make in FY24, including a $1bn Eurobond due in April 2024. In addition, Moody’s estimates The country’s current account deficit at around $10bn.

Pakistan’s financing options beyond June 2023 are highly uncertain. It is not clear that another IMF programme is under discussion and if it does happen, how long the negotiations would take and what conditions would be attached to it.

Elevated social risks and weak governance compound the government’s difficulty in advancing further reforms. Households are already facing high and increasing costs of living. Inflation in Pakistan is very high, with food inflation at 42.9pc and transport inflation at 39.1pc year-on-year in January 2023. Headline inflation is likely to rise further as energy prices increase in tandem with the removal of energy subsidies.

Published in Dawn, March 1st, 2023