SINGAPORE (Reuters) – Moody’s Investors Service on Thursday downgraded the rating of the Pakistani government’s local and foreign currency issuer and that of senior unsecured debt from B3 to Caa1.
The global rating agency also downgraded the MTN senior unsecured program rating to (P)Caa1 from (P)B3. The outlook remains negative.
He said the decision to downgrade the ratings to Caa1 is driven by increased government liquidity and external vulnerability risks and higher debt sustainability risks, following the devastating floods that have hit the country since. June 2022.
“The floods have exacerbated Pakistan’s liquidity and external credit weaknesses and significantly increase social spending needs, while government revenues are severely affected,” the rating agency added.
Debt affordability, a long-standing credit weakness for Pakistan, will remain extremely low for the foreseeable future.
The Caa1 rating reflects Moody’s view that Pakistan will remain heavily dependent on funding from multilateral partners and other public sector creditors to meet debt repayments, in the absence of access to market funding at affordable costs.
In particular, Moody’s expects Pakistan’s Extended Financing Fund (EFF) program to remain in place and provide an opportunity for short-term financing from the IMF and other multilateral and bilateral partners.
The negative outlook reflects risks to Pakistan’s ability to secure the financing needed to fully meet its needs over the next few years.
High social and political risks compound the government’s difficulty in implementing reforms, including revenue-enhancing measures, that would improve the country’s fiscal position and ease liquidity pressures.
The floods will also increase Pakistan’s external financing needs, increasing the risks of a balance of payments crisis.
Pakistan’s weak institutions and strong governance add uncertainty to whether the country will maintain a credible political trajectory that supports additional financing.
The negative outlook also takes into account the risks that, should debt restructuring prove necessary, could extend to private sector creditors.
The Caa1 rating also applies to senior unsecured foreign currency ratings for The Third Pakistan International Sukuk Co Ltd and The Pakistan Global Sukuk Program Co Ltd. The associated payment obligations are, according to Moody’s, direct obligations of the Government of Pakistan.
In conjunction with today’s action, Moody’s lowered Pakistan’s national local and foreign currency caps to B2 and Caa1 from B1 and B3, respectively. The two-notch gap between the local currency ceiling and the sovereign rating is due to the government’s relatively large footprint in the economy, weak institutions, and relatively high risk of political and external vulnerability.
The two-notch gap between the foreign exchange ceiling and the local currency ceiling reflects incomplete capital account convertibility and relatively weak policy effectiveness, indicating significant transfer and convertibility risks despite moderate external debt.
Pakistan’s short to medium term economic prospects have deteriorated sharply due to the floods. Preliminary government estimates put the economic cost of the floods at around $30 billion (10% of GDP), well above the estimated $10 billion economic cost of the 2010 floods, which was the worst so far. episode of flooding of the country.
Moody’s lowered Pakistan’s real GDP growth to 0-1% for FY2023 (the year ending June 2023), from a pre-flood estimate of 3-4%. The floods will affect all sectors, with the impact likely to be most acute in the agricultural sector, which accounts for around a quarter of the economy.
As the economy recovers from the floods, Moody’s expects growth to pick up next year but remain below trend.
The supply shock from the floods will drive prices up further, at a time when inflationary pressures are already high. The monthly inflation rate averaged 25% from July to September 2022.
Moody’s expects inflation to rise to 25-30% on average for fiscal 2023, from a pre-flood estimate of 20-25%. Social risks may increase as households face higher living costs for a longer period, which would have negative economic and fiscal consequences.
In addition, floods are likely to have long-term negative effects on economic and social conditions. There is already a significant increase in waterborne diseases and education is again disrupted for many displaced children soon after schooling resumes after the pandemic.
The sensitivity of the economy to climatic events is taken into account in Moody’s assessment of very negative environmental risks, as explained below.
The growth shock will reduce government revenue, while government spending will be increased by the costs of rescue and relief operations. Moody’s expects the budget deficit to widen to 7-8% of GDP in fiscal 2023, from a pre-flood estimate of 5-6% of GDP.
Pressures on public finances are expected to persist over the next few years, as spending remains high due to reconstruction and social needs.
As a result, Pakistan’s debt affordability – which is already one of the lowest among Moody’s sovereign rates – will deteriorate. Amid rising interest rates and weakening revenue collection, Moody’s estimates that interest payments will rise to about 50% in fiscal year 2023 from 40% of government revenue in fiscal year 2023. 2022, and will stabilize at this level over the next few years.
A large share of revenue devoted to interest payments will increasingly limit the government’s ability to service its debt while meeting the basic social spending needs of the population.
Meanwhile, due to the narrow revenue base, government debt as a share of revenue is very high, at around 600% in fiscal 2022. Moody’s expects this ratio increases further to reach 620-640% in FY2023, well above the median. 320% for Caa-rated sovereigns, despite a more moderate debt-to-GDP ratio at 65-70% in FY2023.
Moody’s expects the current account deficit to widen to 3.5-4.5% of GDP in fiscal 2023, from a pre-flood estimate of 3-3.5%. While imports of a range of goods are expected to decline as demand contracts, imports of food and other essential items such as medical supplies will increase, while export capacity will be hit.
That said, Moody’s expects the larger trade deficit to be partially offset by an increase in remittances which tend to rise in times of crisis.
As the current account deficit widens, Pakistan’s foreign exchange reserves have remained at very low levels, sufficient to cover less than two months of imports, even after the recent disbursement of $1.1 billion from the IMF to the sequel to the seventh and eighth reviews of the EFF program.
This low level of reserves limits Pakistan’s ability to draw substantially on these reserves to meet debt or import payment needs, without risking a balance of payments crisis.
External liquidity conditions have also tightened significantly for Pakistan. Its access to affordable market financing is extremely limited and will likely remain so for some time.
Therefore, Pakistan will remain heavily dependent on funding from multilateral and bilateral partners. Moody’s expects Pakistan’s continued engagement with the IMF to enable it to access IMF financing and related financing from other multilateral partners and official creditors.
Moody’s understands that the government has secured additional commitments from multilateral partners to meet the higher funding needs due to the floods. Nevertheless, the risks remain related in particular to the weakness of the institutions and the strength of the governance of Pakistan, which adds to the uncertainty as to the capacity of the sovereign to maintain a credible and effective policy.
The negative outlook reflects downside risks beyond what would be consistent with a Caa1 rating.
High social and political risks compound the government’s difficulty in implementing reforms, including revenue-enhancing measures, that would improve the country’s fiscal position and ease liquidity pressures. In addition, as mentioned above, Pakistan faces balance of payments crisis risks, which would increase if its external payment needs were higher than currently expected, for example due to larger import needs. , while access to external financing is more restricted.
Additionally, while Moody’s assumes that access to public sector financing will be maintained and sufficient to meet Pakistan’s needs, lower financing and/or higher needs would increase the risk of default to a level that no longer corresponds to a Caa1 rating.
On September 25, the then finance minister indicated that Pakistan would seek debt relief from official creditors on a bilateral basis. The negative outlook also reflects the risks that, if debt restructuring is sought, it could spread to private sector creditors, despite assurances from the government in late September that it is not seeking debt relief. debt of commercial banks or holders of Eurobonds. If so, it would likely constitute a default by Moody’s definition.
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