Fitch downgrades Pakistan’s currency issuer default rating to CCC-

• Fitch downgrades Pakistan due to a host of underlying factors.
• “Default or debt restructuring an increasingly real possibility.”
• CAD can increase once more funding becomes available, it says.

Fitch Ratings has downgraded Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to “CCC-” from “CCC+”, a statement from the agency said Tuesday.

The downgrade reflects further sharp deterioration in external liquidity and funding conditions and the decline of foreign exchange reserves to critically low levels.

Falling reserves reflect large, albeit declining, current account deficits (CADs), external debt servicing, and earlier FX intervention by the central bank, particularly in 4Q22, when an informal exchange-rate cap appears to have been in place, the statement mentioned.

“We expect reserves to remain at low levels, though we do forecast a modest recovery during the remainder of FY23, due to anticipated inflows and the recent removal of the exchange rate cap.”

The rating agency said that while it assumes a successful conclusion of the ninth review of Pakistan’s International Monetary Fund (IMF) programme, the downgrade also reflects large risks to continued programme performance and funding, including in the run-up to this year’s elections.

“Default or debt restructuring is an increasingly real possibility, in our view,” the rating agency said.

The agency added that external public-debt maturities in the remainder of the fiscal year ending June 2023 (FY23) amount to over $7 billion and would remain high in FY24.

Of the $7 billion remaining for FY23, $3 billion represent deposits from China’s State Administration of Foreign Exchange (SAFE) that are likely to be rolled over, and $1.7 billion are loans from Chinese commercial banks which Fitch also assumes would be refinanced in the near future.

The SAFE deposits are scheduled to mature in two instalments — $2 billion in March and $1 billion in June.

‘CAD declining, but may widen again’

Pakistan’s CAD was $3.7 billion in the second half of FY2022, down from $9 billion in the same period of FY2021. As such, Fitch forecasts a full-year deficit of $4.7 billion (1.5% of GDP) in FY23 after $17 billion (4.6% of GDP) in FY2022.

The narrowing of the CAD has been driven by restrictions on imports and foreign exchange reserves availability, as well as by fiscal tightening, higher interest rates and measures to limit energy consumption.

Reported backlogs of unpaid imports in Pakistan’s ports indicate that the CAD could increase once more funding becomes available. “Nevertheless, exchange-rate depreciation could limit the rise, as the authorities intend for imports to be financed through banks, without recourse to official reserves.”

Remittance inflows, it said, could also recover after they were partly switched to unofficial channels in the fourth quarter of FY2022 to benefit from more favourable exchange rates in the parallel market.

The IMF deal

Shortfalls in revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate have held up the 9th review of Pakistan’s IMF programme, which was originally due in November 2022.

“We understand that completion of the review hinges on additional front-loaded revenue measures and increases to regulated electricity and fuel prices.”

The IMF’s conditions are likely to prove socially and politically difficult amid a sharp economic slowdown, high inflation, and the devastation wrought by widespread floods last year, the rating agency said.

Elections are due by October 2023, and former prime minister Imran Khan, whose party will challenge the incumbent government in the elections, earlier rejected an invitation by Prime Minister Shehbaz Sharif to hold talks on national issues, including IMF negotiations.

Fitch further added that recent funding stress has been marked by the apparent reluctance of traditional allies — China, Saudi Arabia and the United Arab Emirates — to provide fresh assistance in the absence of an IMF programme, which is also critical for other multilateral and bilateral funding.

Funding and loans

The authorities, it said, appear close to agreement on the 9th programme review after the conclusion of the IMF’s staff visit to Pakistan on  February 9, and have already taken action that should facilitate agreement.

“This includes an apparent removal of a cap on the rupee exchange rate in January. The prime minister has repeatedly expressed the intention to remain in the programme.”

In addition to remaining IMF disbursements of $2.5 billion, Pakistan stands to receive $3.5 billion from other multilateral lenders in FY23 after an agreement with the IMF is reached.

There have been reports, Fitch said, of over $5 billion in additional commitments being considered by allies, on top of rollovers of existing funding, although details on the size and conditions are still pending. Pakistan received $10 billion in pledges at a flood-relief conference in January 2023, mostly in the form of loans.

Pakistan repaid a sukuk due in December 2022, and the next scheduled bond maturity is not until April 2024.

Back in the day, in a statement before resigning as finance minister, Miftah Ismail said Pakistan would seek debt relief from non-commercial creditors.

In addition, the prime minister had also appealed for bilateral debt relief within the Paris Club framework, although no official request was sent and this is no longer under consideration, according to the authorities.

Should Paris Club debt treatment be sought, Paris Club creditors would be likely to require comparable treatment for private external creditors in any restructuring.

“We believe local debt might be included in any restructuring, despite macro-financial stability considerations, as it accounts for 90% of the government’s interest burden.”