Fitch Ratings Upgrades Pakistan’s Outlook to CCC

According to Fitch, Pakistan's better external liquidity and funding conditions as a result of its Staff-Level Agreement (SLA) with the IMF on a nine-month Stand-by Arrangement (SBA) in June are reflected in the upgrade.

"We anticipate that the IMF board will accept the SLA in July, catalysing further funds and establishing policies in anticipation of the October legislative elections. Despite this, there are still risks associated with programme implementation and external finance because of the unstable political environment and substantial external financing needs, the agency stated in a statement today.

IMF-Supported Reforms

Recently, Pakistan has taken steps to resolve issues with inadequate tax collection, energy subsidies, and policies that conflict with a market-determined currency rate, such as import financing limitations. The past three evaluations of Pakistan's previous IMF programme, which was set to expire in June, were delayed by these problems.

After introducing new tax laws and subsidy reforms in February, the government most recently modified its proposed budget for the fiscal year ending June 2024 (FY24) to reduce spending and add new revenue measures. The government appeared to stop managing the exchange rate in January 2023, but the rules for giving imports priority were still in place until June.

Foreign Deficit Risks

Given the persistence of reports of import backlogs, the industrial sector's reliance on foreign inputs, and the necessity for rehabilitation following last year's floods, the CAD may widen further than Fitch ratings anticipate.

Although the authorities intend for imports to be financed by banks rather than official reserves, currency depreciation might nonetheless control the surge. Remittance inflows may potentially rebound if they partially shifted to unauthorised routes to take advantage of better currency rates available on the parallel market.

The 'CCC' Long-Term Foreign-Currency IDR also takes into account the following elements:

Reserves Still Low: The State Bank of Pakistan's liquid net foreign exchange reserves have been hovering around $4 billion since February 2023, or less than a month's worth of imports, after reaching a peak of more than $20 billion at the end of August 2021. Large CADs, payment of external debt, and early FX intervention by the central bank were all factors in the decline of reserves. According to new external finance flows, the credit rating agency anticipates a moderate rebound for the remainder of FY24; however, these flows will also contribute to a further widening of the CAD.

Politically unstable: After Mr. Khan was briefly detained on suspicion of corruption in May, protests by supporters of the former prime minister and his PTI party significantly increased, culminating in attacks on army facilities. Numerous PTI members were detained during the ensuing crackdown, and some senior PTI lawmakers resigned from office. Nevertheless, Mr. Khan and the PTI continue to enjoy widespread support, which casts doubt on election-related strategy.

Fiscal Deficits Remain Wide: According to Fitch, the consolidated general government (GG) fiscal deficit will increase from an estimated 7.0% of GDP in FY23 to 7.6% of GDP in FY24 due to higher interest costs on domestic debt. This is what separates our forecast from the revised FY24 budget statement, which shows a GG deficit of 7.1% of GDP (with a lower figure of 6.5% in the medium-term fiscal framework). Our projected GG primary deficit will somewhat improve due to fiscal consolidation, going from 0.5% of GDP in FY23 to 0.1% of GDP in FY24.

High, Stable Debt Level: The GG debt/GDP ratio of 74% at FYE23 is in line with the median for sovereigns with ratings of 'B', 'C', and 'D', and debt dynamics are largely stable because of the high nominal growth expected over the medium term. However, compared to rivals, the ratios of debt to sales (over 600%) and interest to revenue (almost 60%) are significantly worse.

Government Considering Extension of Bilateral MaturityPakistan will request maturity extensions on loans from bilateral creditors who are not members of the Paris Club, according to the finance minister, who also reaffirmed the commitment of the government to punctual debt servicing. According to Fitch Ratings, such term extensions would mostly apply to loans and deposits from China, Saudi Arabia, and the United Arab Emirates that are already routinely renewed. The option of requesting debt relief from non-commercial creditors, such as the Paris Club, was mentioned by the prime minister and previous finance minister in 2022, but the authorities now seem to have abandoned this idea. Paris Club creditors are likely to demand identical treatment for private external creditors in any restructuring if Paris Club debt relief is requested.

Governance: ESG Pakistan receives a "5" ESG Relevance Score (RS) for political stability, human rights, institutional and regulatory excellence, and corruption control. The strong weight the World Bank Governance Indicators (WBGI) hold in our in-house Sovereign Rating Model (SRM) is reflected in these results. Pakistan is ranked at the lower 22nd percentile in the WBGI.