Moody’s, a well-known International rating agency, has released a new report on Pakistan’s economy which is a mixture of hope and caution. According to the agency, Pakistan’s economic outlook is stable but the long-term CAA-3 rating remains ‘intact’. At the same time, it has warned that the rating would likely be downgraded if Pakistan were to default on its debt obligations to private-sector creditors who would suffer unimaginable losses.

The reason why Moody’s Investors Service has left Pakistan’s long-term issuer rating unchanged at ‘Caa3’, is that the country is facing high credit risk amid doubts over the new government’s ability to quickly negotiate a new International Monetary Fund loan programme after the current one expires in April 2024.

To quote Moody’s, “Pakistan’s economy faces very high financial risks in the short to medium term. Political risks are also high with the highly contested general election on February 8.” The rating giant has expressed apprehension that the electoral mandate secured by the coalition government does not seem to be strong enough to enable it to undertake long overdue fiscal reforms. As such it will be difficult to get loans from other countries and institutions until the IMF’s new loan program is negotiated and finalised. Moody’s has also warned that Pakistan’s rating may be downgraded in case of debt default.

But, according to the rating agency, Pakistan’s rating may improve if financial and external risks decrease. For this to materialize, Pakistan will have to improve foreign its exchange reserves and boost revenue through recommended tax reforms and slashing of current expenditure. In the opinion of the agency it remains highly uncertain whether the newly elected government of Pakistan would be able to quickly negotiate a new IMF programme soon after the ongoing programme expires in April. The agency has cast doubt over the new government’s ability in the wake of the formation of a coalition government at the centre.

Moody’s has further observed that Pakistan is likely to meet its external debt obligations for the fiscal year ending June 2024, but there is limited visibility regarding the sovereign’s sources of financing to meet its very high external financing needs after the current IMF Stand-By Arrangement ends. It is no secret that the large amount of external financing required over the medium term, combined with Pakistan’s very low reserves position, poses serious default risks if there are delays in funding from the IMF and other partners. Social pressures and weaknesses in governance may also raise challenges in meeting the criteria for future IMF funding.

What is the way out of this tricky situation for the government?

According to experts, the way out is continued and close engagement with the IMF. Such a course of action would help support additional financing from other multilateral and bilateral partners, which could reduce default risk. In such a case Moody’s would also consider upgrading the country’s credit rating. The way forward would require Pakistan to achieve a sustainable increase in foreign exchange reserves along with a resumption of fiscal consolidation, including through implementing revenue-raising measures. All this would result in a meaningful improvement in debt affordability – a plus for credit positive evaluation in the coming days.

In the current volatile political situation, uncertainty looms large around the newly elected government’s willingness and ability to quickly negotiate a new IMF programme soon after the current one expires in April. This is so because a weak coalition government formed under the shadow of a controversial electoral mandate may find it difficult to introduce needed reforms that will form an essential part of a successor IMF programme. Conversely, until a new programme is agreed to, Pakistan’s ability to secure loans from other bilateral and multilateral partners will be severely constrained.

But there is a silver lining in the clouds. According to the global media outlet Bloomberg, Bank of America (BofA) has raised its recommendation for Pakistan dollar bonds to overweight from market weight, citing falling political uncertainty after the elections and possible rating improvements. This prognosis is based on the fact that with the formation of a new government in Pakistan the election-related political uncertainty is subsiding and the government has arranged the repayment of $1 billion loan maturing in April. But ultimately, everything will depend on the likely progress the government makes with the new IMF programme based on its ability to put its economic house in order, including substantial reduction in current expenditure, elimination of waste and flab in bureaucracy and strong action against rampant corruption at various levels. The new Sharif government has a hard task ahead. It remains to be seen how it tackles the challenge.