Global rating agency Moody’s on Tuesday cut Pakistan’s sovereign credit rating by two more notches to ‘Caa3’ — the lowest in three decades — amid international loan negotiations, saying the country’s increasingly fragile liquidity “significantly raises default risks”.

The agency also changed the country’s outlook from negative to stable.

The government has been in talks with the International Monetary Fund (IMF) to secure a $1 billion loan, which has been pending since late last year over policy issues.

It is part of a stalled $6.5bn bailout package, originally approved in 2019.

A payment by the IMF may help to cover Pakistan’s immediate needs, Moody’s said, but warned that “weak governance and heightened social risks impede Pakistan’s ability to continually implement the range of policies that would secure large amounts of financing.”

Islamabad has been undertaking key measures such as raising taxes and removing blanket subsidies and artificial curbs on the exchange rate to secure the funds to avert an economic crisis.

The rating agency also said that there is “very limited visibility” on Pakistan’s sources of financing for its “sizeable external payments needs” beyond the life of the current IMF programme that ends in June 2023.

Pushed to the brink by last year’s devastating floods, Pakistan has reserves barely enough for three weeks of essential imports, while hotly contested elections are due by November.

A Reuters poll on Tuesday showed Pakistan’s central bank may hike rates by 200 basis points in an off-cycle meeting this week to unlock the IMF funds.

Reasons for credit rating downgrade

Elaborating on the reasons for the sovereign credit rating’s downgrade, Moody’s said the government’s liquidity and external vulnerability risks had risen further since the last review in October and foreign exchange reserves had declined to a “critically low level”.

“Amid delays in securing official sector funding, risks that Pakistan may not be able to source enough financing to meet its needs for the rest of fiscal 2023 (ending June 2023) have increased.

“Beyond this fiscal year, liquidity and external vulnerability risks will continue to be elevated, as Pakistan’s financing needs will remain significant and financing sources are far from secure. At the same time, the prospects of the country materially increasing its foreign exchange reserves are low,” Moody’s said.

It estimated that Pakistan’s external financing needs for the rest of the fiscal year would be $11bn.

It added that the country would need to secure financing from the IMF and other multilateral and bilateral partners for these financing needs.

“Despite recent delays, Moody’s assumes successful completion of the ninth review of the existing IMF programme, although this is not secured yet. This would in turn catalyse financing from other multilateral and bilateral partners.

“At the same time, the government will also need to obtain the rollover of the $3bn China SAFE deposits and secure $3.3bn worth of refinancing from Chinese commercial banks for the rest of this fiscal year.”

Moody’s noted that even though this year’s external payment needs may be met, “the liquidity and external position next year will remain extremely fragile.”

“Pakistan’s external debt repayments will remain high for the next few years. Moody’s estimates Pakistan’s external financing needs for fiscal 2024 are around $35-36bn. Pakistan has about $25-26bn worth of external debt repayments (including interest payments) to make in fiscal 2024.”

The agency reiterated that financing options beyond June 2023 were “highly uncertain”.

“It is not clear that another IMF programme is under discussion and if it does happen, how long the negotiations would take and what conditions would be attached to it. However, in the absence of an IMF programme, Pakistan is unlikely to unlock sufficient financing from multilateral and bilateral partners.”

Another major reason it explained for the credit rating downgrade was the constraining of prospects for further reforms due to acute exposure to social risks and weak governance.

“Elevated social risks and weak governance compound the government’s difficulty in advancing further reforms.

“Households are already facing high and increasing costs of living. Inflation in Pakistan is very high,” the agency said, pointing out that headline inflation was likely to rise further as energy prices increased in tandem with the removal of energy subsidies.

“Implementing further measures to raise revenue or cut spending in this environment is extremely socially and politically challenging.”

At the same time, it noted that reforms to raise fiscal revenues remained key to further IMF financing.

Reason for stable outlook

Meanwhile, regarding the change in the country’s outlook, Moody’s said it reflected the agency’s assessment that “credit pressures that Pakistan faces are broadly balanced at a Caa3 rating level.”

“Continued IMF engagement, including beyond the current programme, would likely help to support additional financing from other multilateral and bilateral partners, which could reduce default risk, if this is achieved urgently and without further raising social pressures.

“Conversely, this fiscal year or beyond, financing from the IMF and other partners may not be disbursed in time, which, given the extremely low reserves position, could lead to default,” the agency noted.

Factors leading to rating upgrade or downgrade

Regarding a possible change in the credit rating, Moody’s outlined the below conditions for the two scenarios:

“The rating would likely be upgraded if Pakistan’s government liquidity and external vulnerability risks decreased materially and durably. This could come with a sustainable increase in foreign exchange reserves. A resumption of fiscal consolidation, including through implementing revenue-raising measures, pointing to a meaningful improvement in debt affordability would also be credit positive.

“The rating would likely be downgraded if Pakistan were to default on its debt obligations to private-sector creditors and the expected losses to creditors as a result of any restructuring were larger than consistent with a Caa3 rating.”

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