ISLAMABAD, Sept 23: Moody’s Investors Service on Tuesday downgraded outlook on Pakistan’s government bond rating to negative from stable, saying the country could face difficulties repaying its debts.

The Singapore-based rating agency has also lowered the outlook on its B3 foreign currency bank deposit ceiling to negative because of “a substantial erosion in the country’s external liquidity position, and which is not likely to be adequately reversed by prospective external assistance or ongoing efforts at macro-economic stabilisation”.

The negative outlook on the government’s bond ratings reflects, in particular, a worsening in access to foreign currency, raising a heightened prospect of arrears and missed repayments.

“After the election of President Zardari, domestic political stability may improve somewhat, but underlying tensions will be difficult to remedy”, says Aninda Mitra, Moody’s sovereign analyst for Pakistan.

“Moreover, economic stabilisation measures are expected to remain under pressure from deteriorating socio-economic conditions as well as a worsening external environment, and key macroeconomic objectives may not be met.”

It said the anticipated foreign assistance from official creditors may not prove timely or sufficient to avert near-term financing problems, while considerable delays in disbursements have already contributed to a greater-than-expected erosion of Pakistan’s foreign-exchange reserves, Mitra said.

“As a result, it remains unclear how Pakistan would rebuild its external liquidity in the medium-term, unless either considerably larger amounts of foreign assistance were disbursed, or foreign investor sentiment improved sharply.”

Mitra emphasises that the deterioration in the credit outlook also reflected the lack of a credible medium-term macro-economic framework that could sustainably reduce the country’s imbalances and reassure investors.

“Moreover, the likelihood of further domestic political tumult amidst a growing tide of religious extremism and high inflation could slow structural reform and fundamentally weaken much-needed capacity to generate higher savings, tax revenue and foreign exchange,” he said in a statement.

However, if the depletion in unencumbered foreign exchange reserves were to reverse, with reserves rising substantially towards previously high levels, the outlook could be restored to stable. This would also have to be supported by sustained improvements in Pakistan’s current account balance and net capital inflows over the next year or so, Moody’s said

Pakistan’s B2 rating also already reflects a recent weakening of the government’s finances, so evidence of a structural improvement, including a reversal of deficit monetisation and a substantial deceleration of inflation could support the shift to a stable outlook.

However, the balance of short-term and now even medium-term economic and external financial risks confronting the Pakistani government has tilted to the downside, prompting the negative outlook, it concluded.