Moody’s cuts Pakistan’s rating by two notches to Caa3

KARACHI: Ratings agency Moody’s on Tuesday cut Pakistan’s sovereign credit rating by two notches to ‘Caa3’, saying the country’s increasingly fragile liquidity significantly raises default risks.

Moody’s also changed the country’s economy’s outlook to “stable” from negative. It said the downgrade was triggered by the assessment that Pakistan’s increasingly fragile liquidity and external position significantly raises default risks to a level consistent with a Caa3 rating.

“This was particularly because of the extremely low foreign reserves level, which was far lower than necessary to cover its imports needs and external debt obligations over the immediate and medium-term.”

Pakistan has been in talks with the International Monetary Fund (IMF) to secure a $1 billion loan, which has been pending since late last year over policy issues. It is part of a stalled $6.5 billion bailout package, originally approved in 2019. “Although, the government is implementing some tax measures to meet the conditions of the IMF programme and a disbursement by the IMF may help to cover the country’s immediate needs, weak governance and heightened social risks impede Pakistan’s ability to continually implement the range of policies that would secure large amounts of financing and decisively mitigate risks to the balance of payments,” Moody’s said.

“… in the current extremely fragile balance of payments situation, disbursements may not be secured in time to avoid a default. Moreover, beyond the life of the current IMF programme that ends in June 2023, there is very limited visibility on Pakistan’s sources of financing for its sizeable external payments needs.”

The downgrade to Caa3 from Caa1 rating also applies 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.

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

Government liquidity and external vulnerability risks have risen further since Moody’s last review in October 2022, with forex reserves down to a critically low level, sufficient to cover less than one month of imports. Amid delays in securing official sector funding, there are risks that Pakistan might not be able to source enough financing to meet its needs for the rest of fiscal 2023. Beyond this fiscal year, liquidity and external vulnerability risks will continue to be elevated, as financing needs will remain significant and financing sources far from secure.

At the same time, prospects of the country materially increasing its foreign exchange reserves are low. Overall, Moody’s estimates that Pakistan’s external financing needs for the rest of the fiscal year ending June 2023 would be around $11 billion, including the outstanding $7 billion 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 roll-over of the $3 billion China SAFE deposits and secure $3.3 billion worth of refinancing from Chinese commercial banks for the rest of this fiscal year.

Of this $3.3 billion, Pakistan has already received a deposit of $700 million from the China Development Bank on February 24, 2023. While this year’s external payments needs may be met, the liquidity and external position next year will remain extremely fragile.

External debt repayments will remain high for the next few years. Moody’s estimated Pakistan’s external financing needs for fiscal 2024 at around $35-36 billion. In addition, Moody’s estimated the current account deficit at around $10 billion.

The agency also said that the country’s financing options beyond June 2023 were 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. However, in the absence of an IMF programme, Pakistan is unlikely to unlock sufficient financing from multilateral and bilateral partners,” the ratings agency said.