Fitch upgrades Pakistan to ‘CCC’ after IMF pact

ISLAMABAD: Fitch Ratings on Monday upgraded Pakistan’s long-term foreign currency issuer default rating (IDR) to ‘CCC’ from ‘CCC-’ reflecting reduced external financing risks with improved external liquidity and funding conditions following recent staff-level agreement (SLA) with the IMF on a nine-month Stand-by Arrangement (SBA) in June.

“We expect the SLA to be approved by the IMF board in July, catalysing other funding and anchoring policies around parliamentary elections due by October”, said the US-based rating agency that also noted risks to programme implementation and external funding due to a volatile political climate and large external financing requirement.

In a statement, Fitch said the government had now taken all those steps that had held up three quarterly reviews of the previous $6.5bn Extended Fund Facility (EFF), which expired on June 30. These included measures to address shortfalls in government revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate, including import financing restrictions.

Most recently, the government amended its proposed budget for the fiscal year ending June 2024 (FY24) to introduce new revenue measures and cut spending, following additional tax measures and subsidy reforms in February. The authorities appeared to abandon exchange-rate management in January 2023, although guidelines on prioritising imports were only removed in June.

Talking about implementation risks, the rating agency said Pakistan had an extensive record of going off-track on its commitments to the IMF. “We understand the government has already made all the required policy actions under the SBA. Nevertheless, there is still scope for delays and challenges to implementation as well as new policy missteps ahead of the October elections and uncertainty over the post-election commitment to the programme”, it pointed out.

Fitch said the IMF board approval of the SBA will unlock an immediate disbursement of $1.2 billion, with the remaining $1.8bn scheduled after reviews in November and February 2024. Saudi Arabia and the United Arab Emirates have committed another $3bn in deposits, and the authorities expect $3-5bn in other new multilateral funding after the IMF agreement.

It noted that the SBA would also facilitate the disbursement of some of the $10bn in aid pledges made at the January flood relief conference, mostly in the form of project loans ($2bn in the budget). It said the government expected $25bn in gross new external financing in FY24, against $15bn in public debt maturities, including $1bn in bonds and $3.6bn to multilateral creditors. “The government funding target includes $1.5bn in market issuance and $4.5bn in commercial bank borrowing, both of which could prove challenging, although some of the loans not rolled over in FY23 could now return”.

Also, $9bn in maturing deposits from China, Saudi Arabia and the UAE will likely be rolled over, as in FY23.

Fitch said Pakistan’s current account deficit (CAD) had narrowed sharply, driven by earlier restrictions on imports and FX availability, tighter fiscal and economic policies, measures to limit energy consumption and lower commodity prices.

Pakistan posted current account surpluses in March-May 2023, and we forecast a CAD of about $4bn (1pc of GDP) in FY24, after $3bn in FY23 and over $17bn in FY22. “Our forecast CAD is lower than the $6bn in the budget, on the assumption that not all of the planned new funding will materialise, constraining imports”, Fitch said.

Talking about external deficit risks, Fitch said CAD could widen more than it expected, given continued reports of import backlogs, the dependence of the manufacturing sector on foreign inputs, and reconstruction needs after last year’s floods. Nevertheless, currency depreciation could limit the rise, as the authorities intend for imports to be financed through banks, without recourse to official reserves. Remittance inflows could also recover after partly switching to unofficial channels to benefit from more favourable parallel market exchange rates.

The CCC Long-Term Foreign-Currency IDR also reflected factors like low foreign exchange reserves, volatile politics, high debt levels and wide fiscal deficits.

Fitch in particular noted that protests by supporters of former prime minister Imran Khan and his PTI party sharply intensified in May as Mr Khan was briefly arrested on corruption charges, culminating in attacks on army facilities. In the ensuing crackdown, a large number of PTI members were arrested, with several high-ranking PTI politicians quitting politics. “Nevertheless, the enduring popularity of Mr Khan and PTI create policy uncertainty around elections”.

It pointed out that in 2022, the prime minister and former finance minister Miftah Ismail raised the possibility of seeking debt relief from non-commercial creditors, including the Paris Club, but the authorities now appear to have moved away from this. “Should Paris Club debt treatment be sought, Paris Club creditors are likely to require comparable treatment for private external creditors in any restructuring”.

Published in Dawn, July 11th, 2023