-Cites increased govt liquidity, external vulnerability risks behind the
projection
-Sees worsening near-and medium-term economic outlook
-Estimates interest payments will increase to around 50% in fiscal 2023
By Ali Imran
ISLAMABAD: Moody’s Investor Service cut Pakistan’s sovereign credit rating on Thursday by one notch to Caa1 from B3, citing increased government liquidity and external vulnerability risks, following the devastating floods that hit the country earlier this year.
The floods, caused by abnormal monsoon rains and glacial melt, have submerged huge swathes of the South Asian country and killed nearly 1,700 people, most of them women and children.
The floods will also raise Pakistan’s external financing needs, raising the risks of a balance of payments crisis, according to the rating agency. Moody’s outlook on Pakistan remained unchanged at negative.
“The decision to downgrade the ratings to Caa1 is driven by increased government liquidity and external vulnerability risks and higher debt sustainability risks, in the aftermath of devastating floods that hit the country since June 2022. The floods have exacerbated Pakistan’s liquidity and external credit weaknesses and vastly increase social spending needs, while government revenue is severely hit,” it said in a statement.
It stated that “debt affordability and a long-standing credit weakness for Pakistan, will remain extremely weak for the foreseeable future”.
The Caa1 rating reflected Moody’s view that Pakistan would remain highly reliant on financing from multilateral partners and other official sector creditors to meet its debt payments, in the absence of access to market financing at affordable costs.
“In particular, Moody’s expects that Pakistan’s IMF Extended Fund Facility (EFF) program will remain in place and provide an avenue for financing from the IMF and other multilateral and bilateral partners in the near term.”
The rating agency explained that the negative outlook captured risks around the country’s ability to secure required financing to fully meet its needs in the next few years.
“Elevated social and political risks compound the government’s difficulty in implementing reforms, including revenue-raising measures, that would improve the country’s fiscal position and alleviate liquidity stresses.
“The floods will also raise Pakistan’s external financing needs, raising the risks of a balance of payments crisis. Pakistan’s weak institutions and governance strength add uncertainty around whether the country will maintain a credible policy path that supports further financing. The negative outlook also captures risks that, should a debt restructuring be needed, it may extend to private sector creditors,” the statement said.
Moody’s said the Caa1 rating also applied to the backed foreign currency senior unsecured ratings for The Third Pakistan International Sukuk Co Ltd and The Pakistan Global Sukuk Programme Co Ltd.
The associated payment obligations are, in Moody’s view, direct obligations of the Government of Pakistan, it added.
“Concurrent to yesterday’s action, Moody’s has lowered Pakistan’s local and foreign currency country ceilings to B2 and Caa1 from B1 and B3, 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,” the statement said.
It also stated that the two-notch gap between the foreign currency ceiling and the local currency ceiling reflected the incomplete capital account convertibility and relatively weak policy effectiveness, which pointed to material transfer and convertibility risks notwithstanding moderate external debt.
Further explaining its reasons for the downgrade, Moody’s said Pakistan’s economic outlook in the near and medium term had sharply deteriorated because of the floods.
According to the government’s initial estimates, the economic cost of the floods stood at about $30 million — which accounts to 10 per cent — of the gross domestic product (GDP) and was far above the $10 billion economic loss during the 2010 floods.
“Moody’s has lowered Pakistan’s real GDP growth to 0-1pc for fiscal 2023 (the year ending in June 2023), from a pre-flood estimate of 3-4pc. The floods will affect all sectors, with the impact likely more acute in the agriculture sector, which makes up about one-quarter of the economy,” it said.
Moody’s further expected that even if the economy recovers from the floods, the growth next year would stay “below trend”.
The statement said that the supply shock due to the floods would increase prices further, at a time when inflationary pressures are already elevated.
“Moody’s expects inflation to pick up to 25-30pc on average for fiscal 2023, compared to a pre-flood estimate of 20-25pc.”
Subsequently, it went on, social risks might increase as households would face higher costs of living resulting in negative economic and fiscal implications.
“Moreover, the floods are likely to have long-term negative effects on economic and social conditions. There is already a significant increase in water-borne diseases, and education is again disrupted for many displaced children not long after schooling resumed following the pandemic,” Moody’s said.
Commenting on Pakistan’s debt affordability, Moody’s said: “Against a backdrop of increasing interest rates and weaker revenue collection, Moody’s estimates that interest payments will increase to around 50pc in fiscal 2023, from 40pc of government revenue in fiscal 2022, and stabilise at this level for the next few years.
It said a significant share of revenue going towards interest payments would increasingly constrain the government’s capacity to service its debt while also meeting the population’s essential social spending needs.
Meanwhile, because of the narrow revenue base, the government’s debt as a share of revenue is very high at about 600% in fiscal 2022, the statement said.
Moody’s said that it expected the ratio to rise further to 620-640pc in fiscal 2023, “well above the median of 320pc for Caa-rated sovereigns, despite a more moderate debt-to-GDP ratio at 65-70pc in fiscal 2023”.
This shock would lower government revenues, while government expenditures would be raised by the costs of rescue and relief operations.
Further elaborating on its decisions, the rating agency said it expected Pakistan’s current account deficit to widen to 3.5-4.5pc of GDP for the next fiscal year.
“While imports of a range of goods are likely to decline as demand shrinks, 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 increase at times of crises,” the statement read.
It also highlighted that Pakistan’s foreign exchange reserves have remained at low levels even after the recent IMF disbursement of $1.1 billion, underlining that this low level of reserves “limits Pakistan’s ability to substantially draw down on them to meet debt or imports payments needs, without risking a balance of payments crisis”
Meanwhile, external liquidity conditions have also tightened significantly for Pakistan, it outlined, adding that because of this the country’s access to market financing at an affordable cost was extremely constrained, and was likely to remain so for some time.
Pakistan will, therefore, remain highly reliant on financing from multilateral and bilateral partners, it warned, saying that Moody’s expected Pakistan’s continued engagement with the IMF to enable it to access financing from the IMF and related financing from other multilateral partners and official creditors.
It continued that despite securing additional commitments from multilateral partners, the risk remained, particularly related to Pakistan’s weak “institutions and governance strength” which it said added uncertainty about the country’s capacity to maintain a credible and effective policy stance.
