Fitch, the American credit rating agency, recently came out with a positive outlook on Pakistan’s economy. It has affirmed Pakistan’s long-term foreign-currency issuer default rating (IDR) at ‘B-‘ with a stable outlook. According to Fitch, the ‘B-‘ rating reflects a challenging external position marked by a high external financing requirement and low reserves, weak public finances including large fiscal deficits and a high government debt-to-GDP ratio.
However, the agency has noted that progress is being made towards strengthening external finances and positive steps have been made on the fiscal front, but considerable risks remain. Financing unlocked through an International Monetary Fund (IMF) programme has narrowed the current account deficit and helped building of reserves. Still, external finances remain fragile with relatively low foreign exchange reserves in the context of an elevated external debt repayment schedule and subdued export performance.
The good thing is that the agency projects a further narrowing of the current account deficit to 2.1pc of GDP in the year ending June 2020 (FY20) and 1.9pc in FY21, from 4.9pc in the last fiscal year. Import compression has led to a narrowing deficit, facilitated by a depreciation of the rupee against the US dollar and tighter monetary conditions. Fitch expects gross liquid foreign exchange reserves rise to around USD11.5 billion by FYE20, from USD7.2 billion at FYE19. In its report, Fitch has highlighted the improvement in access to external financing after the approval of a USD6 billion, 39-month Extended Fund Facility (EFF) by the IMF board. According to the IMF, this has potentially unlocked about USD38 billion in financing from multilateral and bilateral sources over the programme period.
The report says that gross external financing needs are likely to remain high over the medium term due to considerable debt repayments. General government debt rose to 84.8pc of GDP, well above the current ‘B’ median of 54pc, due to the currency depreciation, higher fiscal deficit, and build-up of liquidity buffers. Debt/revenue also jumped sharply to 667pc, compared with the historic ‘B’ median of 252pc. Fitch forecasts the fiscal deficit to decline to 7.9pc of GDP in FY20, based on a reversal of the previous year’s one-off factors and revenue-enhancing measures. This is slightly higher than the government’s expectations of 7.5pc due to our more conservative revenue projections. Fitch projects expenditure to rise, particularly as interest-servicing costs increase sharply on the back of higher interest rates.
It is expected that the general government debt to GDP ratio will fall to about 80pc by end-FY21 due to faster nominal GDP growth and fiscal consolidation. The government has taken steps to manage domestic debt rollover risks following the cessation of borrowing from the State Bank of Pakistan (SBP) under the EFF. In particular, the government has reprofiled its SBP debt stock into longer-tenor instruments and has sought to lengthen maturities by issuing longer-term domestic bonds. The government still has roughly 17pc of GDP in upcoming domestic maturities in FY20 compared with the ‘B’ median of 6pc, but has built up its cash buffer to partly mitigate rollover risks.
Tighter macroeconomic policies are further slowing GDP growth, which Fitch forecasts at 2.8pc in FY20 from 3.3pc in FY19. It expects growth to recover gradually to 3.4pc by FY21. Inflation has also continued to rise sharply from the cost pass-through of the currency depreciation and increases in energy tariffs. Inflation will average 11.3pc in FY20 compared with 6.8pc in FY19. The SBP is likely to keep the policy rate at the current peak of 13.25pc in the coming months, before modest cuts towards the end of FY20 as inflationary pressures begin to fade. Pakistan’s rating is constrained by structural weaknesses, reflected in weak development and governance indicators. Per capita GDP of USD1,382 is below the USD3,470 median of its ‘B’ rated peers. Governance quality is also low in Pakistan with a World Bank governance indicator score in the 22nd percentile while the ‘B’ median is in the 38th percentile.
As for the future, Fitch delineates a challenging future. It says the government was consolidating public finances, but progress would be rocky due to the relatively high reliance on revenues to achieve the planned adjustment. It describes the FY20 revenue target as ambitious but hopes the efforts to broaden the tax base through its tax-filer documentation drive and removal of GST exemptions will contribute to stronger revenue growth.
Despite all this, Fitch forecasts the fiscal deficit on the higher side in FY20 as compared to the government’s expectations. However, improvements to the business and security environment could further support the growth outlook. Domestic security has improved over the past couple of years, measured by a decline in terrorist incidents. Nevertheless, ongoing international perceptions of security risks and geopolitical tensions with neighbouring countries continue to weigh on investor sentiment. This will require better perception management at the international level.