NationalVolume 14 Issue # 03

Moody’s and Fitch on Pakistan’s prospects

Two international credit rating agencies –Moody’s and Fitch – have come out with their latest assessments on the health of Pakistan’s economy

According to Moody’s Investors Service, Pakistan’s capability to pay back foreign loans could become weaker if the amount increases further. However, for the present, Pakistan’s foreign exchange reserves are satisfactory enough to pay back foreign loans. About imports in the country, the investors service has said that imports have gone up to fulfill the needs created due to rise in investment in the country. Although increase in investment in Pakistan is inevitable, Moody’s opines that the country has attracted heavy investment also due to the China-Pakistan Economic Corridor.

In an earlier report, Moody’s said that the PTI government would have to walk a tightrope, as its plan to increase development and social spending as well as reduce taxes will clash with the need to further tighten monetary and fiscal policies to reduce economic vulnerabilities. One of top three credit rating agencies in the world, Moody’s has warned that some tough policy decisions may have to be delayed due to implementation of the election manifesto of the PTI. Among other things, the agency described “heightened external vulnerability” as a key economic challenge for the new government.  In its view, possible policy options would include monetary and fiscal policy tightening, further exchange rate depreciation and turning to the IMF for external financing.

Moody’s has also pinpointed the wide range of risks that may further delay policy tightening and PTI moves to fulfil election pledges which includes increasing social spending, reducing taxes – as part of tax reform plans – and lowering energy costs. To get out of the logjam, the new government may have to turn to the International Monetary Fund (IMF) to overcome these challenges. On the basis of past experience, it can be inferred that the IMF will also ask for a steep cut in expenditures, an increase in interest rates and further devaluation of the rupee against the US dollar.

The rupee has already shed its value by close to 22% against the US dollar since December 2017. In this context it is important to keep in mind that the PTI government will face a challenge in the upper house of parliament where it does not enjoy a majority. It may have to reach a compromise with opposition parties in order to introduce legislation. Right now, Pakistan has to tackle a serious challenge to arrange around $11 billion in order to meet the external financing gap in the ongoing fiscal year.

Pakistan faced its highest current account deficit of $18 billion in the last fiscal year, which was equal to 5.8% of gross domestic product (GDP). The Ministry of Finance has not yet officially released the budget deficit figures, but provisional estimates suggest the deficit would remain close to 7% of GDP or Rs2.4 trillion. Both the budget deficit and current account deficit have reached unsustainable levels, which Pakistan cannot afford due to low level of official foreign currency reserves at $9 billion and low tax-to-GDP ratio, standing at only 11.1% by the end of 2017-18. PTI’s plan to lower the number of taxes and their rates to improve the country’s competitiveness will make it difficult to achieve fiscal consolidation in its initial years. PTI also plans to lower the cost of doing business by decreasing energy cost.

In the longer term, Pakistan’s credit challenges include the country’s very low global competitiveness, institutional weaknesses relating to governance, rule of law and control of corruption and a narrow tax base. However, the silver lining on the horizon is the ongoing implementation of the China-Pakistan Economic Corridor which will bring about improvements in power supply and infrastructure. This in turn will raise economic competitiveness and boost industrial activity. Another plus point is the anti-corruption platform on which PTI contested the election. The anti-corruption policy has the potential to address some long-standing institutional weaknesses and improve governance.

On the other hand, another reputed international rating agency Fitch has in its latest commentary said that Pakistan’s declining foreign exchange reserves and widening current account deficit are adding to the country’s external financing risks. According to Fitch, the current account deficit may reach 5.3% of GDP in FY18, compared with 4.7% previously. Export performance has improved, but imports have risen on higher oil prices and strong household demand. Further, loose fiscal policy has added to imbalances. The fiscal deficit is likely to rise to around 6% of GDP in FY18, compared to the earlier forecast of 5.0%.

Fitch says that China’s continued willingness to provide financing and likely inflows from the tax amnesty scheme may reduce near-term risks, but the cost of external market financing has been rising dangerously for Pakistan, with yields on the government’s November 2017 10-year Eurobond up more than 200bp since issuance. The cost could increase further amid continued global monetary tightening and rising geopolitical pressures. Vulnerabilities could be tested as rising debt-servicing payments start to add to external funding requirements from 2019 onwards.

The Fitch rating agency has also revised downwards its FY19 growth estimate for Pakistan from 5.5% to 5.0%: “Economic growth has been robust over the past year, and we expect the economy to expand by 5.5% in FY18. However, we have revised down our FY19 growth estimate to 5.0%, from 5.5% in the January review, to reflect the likely impact of further tightening measures to alleviate external imbalances.”