Fitch Ratings agency has revised the Outlooks on Pakistan’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Negative from Stable and affirmed both IDRs at B. According to the agency, the new rating reflects a high public debt/GDP ratio, weak governance standards as measured by World Bank indicators, domestic political and security risks and a fragile external position, which are balanced by relatively strong growth. Since the successful completion of the three-year IMF Extended Fund Facility in September 2016, reserves have declined and the fiscal deficit has widened. Measures have recently been taken to address these trends, including some currency depreciation, tax rebates on exports, and import duties on non-essential items. However, these have proved insufficient thus far to arrest an ongoing decline in reserves. Moreover, political uncertainty and upcoming elections are, in Fitch’s view, likely to constrain the government’s ability to address them convincingly in the near term.
Fitch forecasts that reserves (including gold) will fall to USD16.8 billion at end-FY18 (2.9 months of external current account payments), after having peaked at USD22.6 billion at the end of the IMF-programme in October 2016. This forecast incorporates proceeds from the USD2.5 billion in sukuk and Eurobond issuances at end-November 2017. The decline in reserves is driven by a rise in Pakistan’s current account deficit, which widened to 4.1% of GDP in the fiscal year ending June 2017 (FY17) from 1.7% in FY16. Despite the rising external and fiscal pressures, Pakistan’s growth performance has continued to improve, with annual GDP growth accelerating to 5.3% in FY17. This compares favourably with the B country median of 3.5%. Fitch forecasts that growth momentum will be sustained, at 5.5% in FY18 and FY19, bolstered by recent investments under the CPEC initiative and reduced capacity constraints.
Inflation in FY17 was low relative to Pakistan’s historical average at 4.1%, but Fitch expects inflation to pick-up to around 5.5% over the next year due to pass-through from rupee depreciation and higher energy prices. Credit growth in the banking sector is robust. The system poses only limited risks to the sovereign as it is well capitalised and small relative to GDP. Non-performing loans have continued to decline from a peak of 14.8% of total loans in end-June 2013, but remain elevated at 9.4%. The accumulation of losses in public sector enterprises (PSE), particularly electricity distribution companies, previously led to fund injections from the federal government to clear debt.
Efficiency improvements, higher tariffs and relatively low global energy prices have helped cut PSE losses from previous highs, but losses have begun to trend upward again. The lack of faster progress towards privatisation impedes further progress in this area. PSE losses could rise considerably if Pakistan suffers an economic shock or there is a sharp rise in energy prices, ultimately feeding through to the government balance sheet. Pakistan’s rating is constrained by structural weaknesses relating to the level of development and governance indicators. Per capita GDP stands at USD1,541, well below the USD3,376 median of its B rated peers. Needless to say, Pakistan’s rating will not improve without improving the low level of governance quality.