Moody’s recent upgrade of Pakistan’s credit rating to ‘Caa2’ from ‘Caa3’ marks a significant turning point for the nation’s economic outlook. As Pakistan inches closer to securing a $7 billion IMF loan, this upgrade signals reduced risks of a balance of payments crisis and reignites investor confidence, potentially unlocking new avenues for financial support and economic recovery.

Moody’s Ratings has elevated Pakistan’s domestic and foreign currency issuer and senior unsecured debt standing to ‘Caa2’ from ‘Caa3,’ revising the outlook to positive from stable. This enhancement materializes just weeks before Pakistan’s anticipated $7 billion International Monetary Fund (IMF) loan program, suggesting a diminished likelihood of the nation’s default on foreign debt payments, despite enduring governance challenges and political turbulence.

This decision by one of the globe’s premier rating entities has revitalized foreign investor confidence in Pakistan’s economic landscape, potentially paving the way for the nation to re-enter international capital markets. Pakistan may now secure fresh foreign debt financing by issuing Panda bonds, Eurobonds, and Sukuk at comparatively reduced costs. In July, Fitch Ratings also upgraded Pakistan’s credit assessment, marking the second upward adjustment by the agency within a year. It is anticipated that S&P Global will soon follow suit.

In a comprehensive rating analysis, Moody’s articulated that the upgrade to ‘Caa2’ reflects Pakistan’s enhancing macroeconomic conditions, along with moderately improved government liquidity and external positions compared to previously exceedingly frail levels. “Consequently, Pakistan’s default risk has declined to a threshold consistent with a Caa2 rating. There is now heightened certainty regarding Pakistan’s sources of external financing, subsequent to the sovereign’s staff-level accord with the IMF on July 12, 2024, for a 37-month Extended Fund Facility (EFF) amounting to $7 billion,” Moody’s noted. The agency anticipates that the IMF Board will sanction the EFF within weeks.

Pakistan’s foreign exchange reserves have almost doubled to $9.3 billion since June 2023, although they remain beneath the levels requisite to satisfy the country’s external financing needs. The nation continues to rely on timely funding from official partners to fully meet its external debt obligations. “The governments of Saudi Arabia and the United Arab Emirates have jointly committed to invest $15 billion in Pakistan, which, if actualized, would significantly augment Pakistan’s foreign exchange reserves. Moreover, the government endeavors to expand its revenue base through measures such as increasing taxes on the agriculture, retail, and export sectors. If implemented and sustained, these measures could enhance Pakistan’s debt affordability beyond our current projections.”

However, it cautioned that Pakistan’s ‘Caa2’ rating continues to reflect the country’s exceedingly weak debt affordability, posing substantial debt sustainability risks. “We anticipate that interest payments will continue to consume approximately half of government revenue over the next two to three years. The ‘Caa2’ rating also incorporates the nation’s frail governance and heightened political uncertainty.”

The positive outlook encapsulates a balance of risks, with a propensity toward potential enhancement. It accounts for the possibility that the government could further mitigate its liquidity and external vulnerability risks and achieve a stronger fiscal position than presently anticipated, underpinned by the IMF program.

Persistent reform implementation, particularly in the realm of revenue augmentation, could widen the government’s fiscal capacity and enhance Pakistan’s debt sustainability. Demonstrating a consistent track record of timely IMF reviews would empower Pakistan to secure necessary financing from official partners, ensuring it meets its external debt commitments while facilitating the ongoing replenishment of its foreign exchange reserves.

In clarifying the reasoning behind its rating upgrade, the agency indicated that its earlier apprehensions regarding the severe risks of a balance of payments crisis have somewhat subsided, though the risks remain significantly high. Pakistan’s dependence on timely and adequate financial support from official partners continues to be pivotal. “There is now increased certainty surrounding Pakistan’s avenues for securing the financing required to fulfill its obligations over the next two to three years, following the IMF’s staff-level agreement. The IMF programme is anticipated to aid Pakistan in unlocking further financial support from other multilateral and bilateral entities.”

Moody’s projects Pakistan’s external financing requirements to be approximately $26 billion for fiscal 2025 (concluding in June 2025), encompassing around $22 billion in external principal debt repayments, along with an additional $4 billion (about 1% of GDP) to cover the current account deficit. The financing needs for fiscal 2026-2027 are expected to be comparably substantial. Moody’s foresees that Pakistan will address these financing needs through support from official partners, though uncertainties linger regarding the government’s capacity to sustain reform initiatives. “The coalition government, established post-elections in February 2024, may lack a robust electoral mandate to enact revenue-raising measures without inciting social unrest. Any deviations in the execution of reforms could result in delays or the disruption of financial support from official partners.”

The government forecasts a fiscal deficit of 5.9% of GDP, coupled with a primary surplus of 2% for fiscal 2025, compared to a 6.8% deficit and 0.9% surplus for fiscal 2024. “We anticipate the pace of fiscal consolidation will be slower than the government’s projections. We estimate a broader fiscal deficit of around 6.5% of GDP and a more modest primary surplus of approximately 0.5-1% of GDP for fiscal 2025.”

The rating elevation to ‘Caa2’ from ‘Caa3’ extends to the backed foreign currency senior unsecured ratings for The Pakistan Global Sukuk Programme Co Ltd. According to Moody’s, the related payment obligations are deemed direct commitments of the Pakistani government, with the programme’s outlook remaining positive.

The upgrade offers a glimmer of hope for Pakistan’s economic future, but challenges remain. The nation’s ability to sustain reform efforts and secure timely financing from official partners will be crucial in navigating the road ahead. With the IMF programme in place, Pakistan has a unique opportunity to stabilize its economy, but the path forward will require careful management of both fiscal policies and political dynamics.