KARACHI, July 13: Moody’s Investors Service on Friday downgraded Pakistan's foreign and local currency bond ratings by one notch to Caa1 from B and said the outlook is negative.

The agency calculated its assessment on several grounds, including deterioration in the country’s balance of payments over the past year, the looming large repayments due to the International Monetary Fund (IMF), the dwindling foreign exchange reserves and the institutional weakness stemming from political instability and constrained government finances.

The driver of Moody’s one-notch downgrade of Pakistan’s government bond ratings is the increasing strain on the country’s external payments position as a result of a rising trade deficit and decline in capital inflows.

Weak government finances, structural inflationary pressures and domestic political uncertainties are adding to Pakistan’s external vulnerabilities and debt sustainability, compounding the downward pressure on sovereign creditworthiness, said a press release issued by the Moody’s.

While Pakistan recorded a small current account surplus in 2010-11, the country’s current account reverted to a deficit of US$3.8 billion during the period from July 2011 to May 2012.

The reason for the deficit in the current account balance lies primarily in the stalled export growth recorded in the eleven months — in contrast to a significant 28.9 pre cent expansion in 2010-11 — due to the collapse in demand from Europe, the country’s biggest export market, and weakening cotton prices. In addition to the deteriorating current account deficit, Moody’s also expects the country’s capital account to exert further pressure on the balance of payments.

Based on recent trends, Moody’s expects that FDI will fall short of US$1 billion in 2012.

In view of the gloomy global economic outlook, Moody’s does not foresee an improvement in the current account over the near term.

The large repayments due to the International Monetary Fund (IMF) represent the second factor that dictated Moody’s decision to downgrade.

The amounts of repayments that are due to the IMF in 2013 and 2014 alone are equivalent to almost half of the State Bank’s current reserve holdings.

The third driver of the downgrade is the dwindling foreign exchange reserves, which have declined steadily after reaching a peak of US$16.8 billion in July last year.

Lastly, the fourth driver of Moody’s rating action is the factious relationship between the country’s elected leaders, the judiciary and the military. The friction undermines the government’s ability to make policies to address pressing domestic economic challenges, to bolster investor confidence and to attract a much needed external financial support from official creditors and donors.