Fitch Ratings’ recent decision to maintain Pakistan’s rating at CCC positive has brought attention to the intricacies of the country’s economic situation. This rating, stable since July 10, 2023, reflects the ongoing efforts to manage substantial credit risk amid external funding challenges. The backdrop of a staff-level agreement (SLA) on a $3 billion Stand-By Arrangement (SBA) with the International Monetary Fund (IMF) underscores the delicate balance Pakistan faces in sustaining economic stability.

Fitch has maintained Pakistan’s rating at CCC positive, a rating that has remained stable since July 10, 2023, when it was upgraded from negative to positive CCC. This upgrade was prompted by the announcement of a staff-level agreement (SLA) on the $3 billion nine-month-long Stand-By Arrangement (SBA) with the International Monetary Fund (IMF) on June 29. The conditions for the upgrade were met by the then Shehbaz Sharif-led government.

The ratings CCC plus and CCC negative indicate a country with substantial credit risk, where default is a real possibility. The rating agency attributes this risk to “high external funding risks.” Its assessment aligns with the IMF’s statements in its SBA documents dated June 30, noting that public debt is projected to decline slowly and will require robust continuation of prudent policies beyond the program period scheduled to end on April 12, 2024. The margin of error for policy slippages and delays in urgently needed structural reforms remains minimal.

Fitch’s evaluation of Pakistan’s Environmental, Social, and Governance (ESG) percentile rank below 50 for political stability and rights highlights concerns such as a shrinking space for political expression. The agency notes negative impacts on the country’s credit profile, citing a history of Pakistani administrations reversing or not adhering to pledged reforms to multilaterals. This explains the IMF’s insistence on “front-loaded” implementation of conditions. The revised budget, following the SLA, envisions external loans of 6,874 billion rupees (23 to 24 billion dollars). This constitutes 47.5 percent of the total budget outlay of 14,460 billion rupees and a concerning 73 percent of the revised tax revenue target of 9,400 billion rupees. The reliance on external funding is crucial for funding the budget in the current year.

The caretaker finance minister acknowledged an unbudgeted 80 billion rupees for incentivizing remittance inflows through official channels. However, details regarding disbursements and adjustments remain unclear. The current situation, as acknowledged by the caretaker finance minister, prohibits the government from borrowing at exorbitant rates in the external market due to the country’s poor ratings.

Interestingly, Fitch reflects the prevailing sentiment in the country, anticipating general elections to take place as scheduled in February and expecting a coalition government similar to Shehbaz Sharif’s government. The report notes that while Imran Khan’s Pakistan Tehreek-e-Insaf party remains popular, electoral prospects may be limited by Khan’s imprisonment and the departure of senior leaders. Political expression has shrunk since widespread protests in May 2023. The report warns that delays to elections or renewed political volatility could jeopardize IMF negotiations and external funding, underscoring the inextricable link between politics and economics in the current economic impasse.

As per the State Bank of Pakistan, the severe monsoon floods inflicted substantial damage on economic activity, triggering inflationary pressures, intensifying stress on external accounts, and exacerbating fiscal imbalances due to expenditures on relief initiatives. Simultaneously, the uncertain global economic and financial conditions, though witnessing a softening—albeit persistently high—trend in global commodity prices, coupled with elevated debt servicing and reduced external inflows, had ramifications across various sectors of the economy. The convergence of these factors significantly undermined Pakistan’s macroeconomic performance during FY23. Real GDP growth plummeted to its third-lowest level since FY52, while the average National Consumer Price Index (CPI) inflation surged to a multi-decade high. Although the current account deficit narrowed considerably, the restrained foreign inflows continued to exert pressure on the external account, leading to a decline in the State Bank of Pakistan’s (SBP) foreign exchange reserves. Meanwhile, reflecting the unsustainable fiscal policy stance of the past several years, a sharp rise in interest payments, persistent large energy subsidies, and lower-than-targeted tax collection contributed to a fiscal consolidation that fell short of the envisioned goals during FY23.

The report underscores that Pakistan’s economic performance in FY23 underscores the critical need to address perennial structural impediments that pose significant risks to the country’s macroeconomic stability. Chief among these challenges are the insufficient and slow tax policy reforms that have constrained the resource envelope, even for meeting current expenditures.

Concurrently, inefficiencies in public sector enterprises (PSEs) have perpetually drained fiscal resources, limiting the space for essential development spending required to enhance the economy’s productive capacity. The meager investment in physical and human capital, as well as research and development (R&D), has hindered the development of a technology-intensive manufacturing base and the progression toward value-added exports.

Furthermore, stagnant crop yields and a lack of attention to developing the food supply chain, coupled with neglect of addressing food market imperfections, have resulted in a sustained dependence on imported food commodities. These trends underscore the unsustainable current account balance, heightening the country’s vulnerability to global supply shocks.

As Pakistan grapples with economic challenges, Fitch Ratings’ assessment serves as a crucial lens through which to view the nation’s credit risk and economic prospects. The maintenance of the CCC positive rating signals cautious optimism, rooted in the SLA with the IMF. However, the reliance on external funding, coupled with concerns about political stability and rights, highlights the intricate dance between politics and economics. Navigating through the current economic impasse requires not only prudent policies but also a resilient political landscape. The anticipation of general elections and potential shifts in political dynamics adds a layer of uncertainty, reinforcing the interconnectedness of these two pivotal aspects in Pakistan’s current economic narrative.