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.
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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 today’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.
Near- and medium-term economic outlook
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.
Debt sustainability risks
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.
Liquidity and external vulnerability risks
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.
Finance Ministry calls rating ‘not truly reflective’
Meanwhile, the Finance Ministry has “strongly contested” Moody’s rating, saying that it was announced without prior consultations and meetings with the government and the State Bank of Pakistan (SBP).
A press release issued by the ministry today said that government policies over the last few months, had in fact, helped in fiscal consolidation, insisting that Pakistan had adequate liquidity and financing arrangements to meet its external liabilities.
“Pakistan is currently under the IMF Programme, the continuity of which is based on the confirmation and confidence in the country’s ability to maintain fiscal discipline, debt sustainability, and its ability to discharge all its domestic and external liabilities.”
The press release argued that Moody’s “worsening near- and medium-term economic outlook” did not depict the correct picture due to gaps in the information available with the rating agency and its use of estimations was not “grounded in fundamentals”.
“As such, the estimate of the economic cost of the floods at $30 billion is premature as the data is still being compiled in collaboration with World Bank and other partners, to ensure transparency and accuracy, and will be available once the figures are firmed up,” it said.
Thus, the ministry said, the impact on the GDP growth rate could not be fully and accurately assessed at this time. “Hence, Moody’s downward revision of GDP growth rate at 0-1pc has no solid basis.”
It also contested translating economic losses into fiscal deficit.
“On the expenditure front, the government will largely be involved in public infrastructure rebuilding, and that too, over a number of years. The uptick in urgent current expenditure is being met through re-allocations and re-appropriations of budgeted funds thus mitigating the risk of rising deficit.
On the revenue front, the increase in nominal GDP is likely to compensate for any dip in revenues,“ it added.
The ministry recalled that during recent meetings with multilaterals, the government had received additional funding commitments from the Asian Development Bank (ADB) of over $2.5 billion.
“Similarly, World Bank has also pledged additional funding of around $1.3 billion for infrastructure and other projects in the current financial year.”
The press release added that on the appeal of United Nations Secretary General Antonio Guterres, funds of $816 million were pledged by countries at a conference in Geneva on October 04, 2022.
“We expect further funding from multilaterals and friendly countries in the donor conference planned to be held in Pakistan in November this year. Consequently, we expect the external sector to improve further in line with the increase in liquidity.”
The impression of restructuring Pakistan’s debt is refuted unequivocally as currently no such proposal is under consideration or is being pursued as has been categorically stated by Finance Minister Ishaq Dar, the statement reads.
Furthermore, giving key numbers to understand the government’s performance, the ministry said that the Federal Bureau of Revenue had collected 28pc taxes in September.
“Similarly, the recent post-flood performance numbers of various sectors of the economy including agriculture and livestock show that its impact on the current account deficit is likely to be moderate compared to that assumed by Moody’s.
“Commodity prices, especially crude oil, have eased compared to a month ago, this would help in offsetting some of the impacts of floods on the current account deficit. The downward trend of the deficit during the past months of FY23 has already been widely reported,” it said.
The ministry added that the overall situation of the country, especially in the post-flood scenario, needed to be seen in the context of the steps taken by the government for relief and recovery and the assistance and commitments by the global community, including multilaterals and bilaterals, to help in the rehabilitation and reconstruction phase.
“The Ministry of Finance strongly feels that the downgrading of Pakistan’s rating is not truly reflective of Pakistan’s macroeconomic conditions.”
‘Dangerous downward spiral’
Pakistan Initiative at Atlantic Council’s South Asia Centre Director Uzair Younus said following Moody’s downgrade, Pakistan’s Eurobonds were “down 50c to 1pt”.
“Most now trading at 10-12pts above Sri Lanka, whose bonds are currently in default. Something worth thinking over for those who think a stronger PKR, lower rates, and higher growth are possible in the current context,” he tweeted.
PTI leader Asad Umar said that while the “dangerous downward spiral” continued, the government was focused on threatening arrests.
Former finance minister Shaukat Tarin called the rate a “double downgrade” since PTI’s exit.
PTI leader Hammad Azhar called the rating the “price of NRO 2”.