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

• The net liquid forex reserves of the (SBP) were around $2.9 billion on February 3, 2023.
• The SAFE deposits are scheduled to mature in two instalments: $2 billion in March and $1 billion in June.
• Pakistan received $10 billion in pledges at a flood relief conference in January 2023.

KARACHI: The Fitch Ratings has downgraded Pakistan’s long-term foreign currency issuer default rating (IDR) to ‘CCC-’, from ‘CCC+’.

“There is no outlook assigned, as Fitch typically does not assign Outlooks to ratings of ‘CCC+’ or below,” the rating agency said in a statement issued on Tuesday.

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

“While we assume 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. The default or debt restructuring is an increasingly real possibility, the rating agency added.

The net liquid forex reserves of the State Bank of Pakistan (SBP) were around $2.9 billion on February 3, 2023, or less than three weeks of imports, down from a peak of more than $20 billion at the end of August 2021.

The falling reserves reflect large, albeit declining, current account deficits, external debt servicing and earlier forex intervention by the central bank, particularly in the fourth quarter of 2022, when an informal exchange rate cap appears to have been in place.

“We expect the 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,” it added.

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

Of the $7 billion remaining for FY23, $3 billion represent deposits from China (SAFE) that are likely to be rolled over and $1.7 billion are loans from the Chinese commercial banks, which we also assume will 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.

Pakistan’s current account deficit was $3.7 billion in the second half of 2022, down from $9 billion in the same period of 2021. As such, we forecast a full-year deficit of $4.7 billion (1.5 per cent of GDP) in FY23 after $17 billion (4.6 per cent of GDP) in FY22.

The narrowing of the current account deficit has been driven by the restrictions on imports and forex availability, as well as by the fiscal tightening, higher interest rates and the measures to limit energy consumption.

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

The remittance inflows could also recover after they were partly switched to unofficial channels in the fourth quarter of 2022 to benefit from more favourable exchange rates in the parallel market.

The shortfalls in revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate have held up the ninth review of the IMF programme, which was originally due in November 2022.

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

The IMF 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 elections are due by October 2023, and former premier 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 the national issues, including the IMF negotiations.

The 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.

The authorities appear close to an agreement on the ninth review after the conclusion of the IMF’s staff visit to Pakistan on February 9, 2023 and had already taken action that should facilitate the 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.

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

There have been reports of over $5 billion in additional commitments being considered by allies, on top of rollovers of the 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.

The prime minister has also expressed the intention to remain current on all debt obligations. Pakistan repaid a Sukuk due in December 2022 and the next scheduled bond maturity is not until April 2024.

The previous finance minister said before resigning that Pakistan would seek debt relief from the non-commercial creditors.

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

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

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

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