The international rating agency Moody’s has upgraded Pakistan’s long-term sovereign credit rating from Caa3 to Caa2. This is good news as it means that  the country’s troubled economy has transited to a safer zone – from  stable to positive. The rating upgrade is driven by Pakistan’s improving macroeconomic indicators, especially liquidity and its external position, which have improved from extreme weakness following a staff-level agreement with the IMF for a fresh $7bn bailout.

But there is a caveat here. Despite the upgrade, the new rating still remains within the agency’s narrow speculative grade band and continues to reflect the country’s “very weak debt affordability that drives high debt sustainability risk”. However, a positive aspect is that according to the agency Pakistan’s default risk has reduced even though the nation’s interest payments would continue to absorb about half of government revenues over the next  two to three years.

Earlier, the global credit rating agency Fitch also upgraded Pakistan’s long-term foreign-currency issuer default rating (IDR) to CCC+ from CCC on the back of the country’s deal with the International Monetary Fund (IMF). According to Fitch, a CCC rating is a speculative or junk grade indicating the issuer has a high risk of defaulting on its debt obligations. Last year, the agency had upgraded Pakistan’s long-term foreign currency issuer default rating from ‘CCC-’ to ‘CCC’ in July, following the approval of an IMF loan. However, the rating had still indicated a significant country credit risk.

It may be added here that Pakistan and the IMF reached a three-year, $7 billion aid package deal on July 12, 2024, giving much-needed respite to the managers of the national economy. Fitch highlighted that the effective performance of the government in the previous IMF agreement helped the country narrow fiscal deficits and rebuild foreign exchange reserves.

However, it noted that the country would be vulnerable if it failed to implement long overdue reforms. The agency also said that it assumed that by the end of August, the government will have to “obtain new funding assurances from bilateral partners, chiefly Saudi Arabia, the UAE, and China. Fitch further noted the ambitious reforms by the government, adding that it aimed to “tackle long standing structural weaknesses in Pakistan’s tax system, energy sector and state-owned enterprises, alongside a commitment to exchange rate flexibility and improvements in the monetary policy framework”.

It also commended the government target of a 3 per cent increase in tax-to-GDP “from under 9pc in FY24, including through higher taxes on the country’s influential agricultural sector, which will have to be legislated at the provincial level”. Fitch also noted that although the country’s foreign exchange reserves (FX) have recovered, they still remained low.

It highlighted that the State Bank of Pakistan (SBP) “is rebuilding FX reserves amid inflows of new funding and limited CADs (Current Account Deficit)”. “We estimate official gross reserves, including gold, rose to over $15 billion at June 2024 (about three months of imports), from nearly $10 billion at end-June 2023,” it said, adding that the agency expected “them to rise to nearly $22 billion by FY26, close their 2021 peak”. The announcement of another one per cent reduction in the interest rate by the State Bank of Pakistan was another sign of economic improvement.

The improvement in the country’s investment risk profile, as reflected by the rating upgrades by two major agencies within a month, should help reduce Pakistan’s country risk profile and boost investor confidence. The stock market upsurge following  Moody’s elevated confidence in this economy was a proof of this.

Needless to say, Moody’s report would go a long way in facilitating the government’s return to the global bond markets and commercial banks for fresh funds it aims to raise by the next fiscal year for budgetary support and covering the gross external financing slippage, one of the reasons for the delayed IMF approval. With a better rating, the government would be able to negotiate less harsh terms and lower interest rates with the foreign commercial banks.

However we should not forget that Moody’s, like Fitch, has warned that uncertainty persists regarding the government’s ability to implement reforms sustainably. It says that the coalition government led by the PML-N formed after the February elections may not have a sufficiently strong electoral mandate to continually implement revenue-raising measures without stoking social tensions. The potential) slippages in reform implementation could lead to delays in or withdrawal of financing support from (multilateral and bilateral) official partners. In the given circumstances, the government can ill-afford any digression from the IMF reforms, including revenue-raising measures, if it wants to ensure timely reviews of the Fund programme, and continually unlock financing from official partners to meet its external debt obligations. All said, despite the upgrade, Pakistan’s economy is not yet out of the woods.