FeaturedNationalVOLUME 19 ISSUE # 16

Persistent challenges for economic stability

Moody’s recent decision to maintain Pakistan’s credit rating at Caa3 with a stable outlook highlights the nation’s ongoing financial vulnerabilities. Despite a period of economic stability and reform efforts, the upcoming coalition government faces substantial hurdles in securing necessary reforms and loans, posing heightened risks of default.

Moody’s decision to maintain Pakistan’s long-term credit rating at Caa3 with a stable outlook underscores the nation’s precarious position in global financial markets due to its financial constraints. Moody’s Investors Service, a leading global credit rating agency, indicated that Pakistan’s credit rating could see an upgrade if the government successfully reduces liquidity and external vulnerability risks in a sustained manner. Despite a recent period of economic stability and reform efforts by the caretaker government, Moody’s retained Pakistan’s long-term issuer rating at ‘Caa3,’ citing very high liquidity and external vulnerability risks, along with weak fiscal strength and heightened political risks.

The agency expressed uncertainty about the newly elected government’s ability to swiftly negotiate a new International Monetary Fund (IMF) program after the current one expires in April. It acknowledged Pakistan’s sizable economy and moderate growth potential as factors contributing to its moderate economic strength. However, it emphasized the persistent challenges, including the country’s very high external financing needs and limited foreign exchange reserves.

While the caretaker government’s reforms garnered support from the IMF and other partners, Moody’s warned that meeting external financing requirements post-April 2024 remains uncertain. The agency highlighted the importance of continued IMF engagement to secure additional financing and reduce default risk. It also suggested that an upgrade in Pakistan’s credit rating would depend on a significant and lasting reduction in government liquidity and external vulnerability risks, possibly accompanied by a sustainable increase in foreign exchange reserves and fiscal consolidation.

Conversely, a downgrade could occur if Pakistan defaults on its debt obligations to private-sector creditors, leading to larger-than-expected losses inconsistent with a Caa3 rating. Moody’s expressed concern about the high political risks in Pakistan following controversial general elections and questioned the ability of the potential coalition government to swiftly negotiate a new IMF program after the current one expires in April.

“The upcoming coalition government may lack the necessary electoral mandate to pursue challenging reforms likely required by a succeeding program. Until a new program is agreed upon, Pakistan’s ability to secure loans from other bilateral and multilateral partners will be severely constrained,” Moody’s stated. The current credit rating signifies a heightened risk of default and increased investment risks, given weak debt affordability. It also considers Pakistan’s low growth rate and susceptibility to extreme weather events, which could elevate economic and social costs. The country’s high debt-servicing requirements limit fiscal flexibility for critical expenditures on infrastructure and social initiatives.

Global rating agencies have consistently categorized Pakistan as a ‘speculative grade’ economy due to its substantial credit risk stemming from liquidity and external vulnerability challenges. A year ago, Moody’s downgraded Pakistan from Caa2 to Caa3, placing it near the bottom of the riskiest markets, following the IMF’s suspension of funding due to the failure to meet previous program goals. Despite the IMF providing a short-term $3 billion loan last summer, Moody’s latest decision highlights ongoing concerns about default risks, particularly amid political uncertainty post the February 8 elections.

The agency emphasizes that the high political risks persist, citing uncertainty about the new government’s willingness and ability to swiftly enter a new IMF program necessary for attracting additional financing. The coalition government’s decision-making capacity is expected to be severely constrained, given potential limitations in its electoral mandate to implement necessary reforms. Moody’s underscores that the fears of default will persist unless a new, larger loan agreement is reached with the IMF.

While the current IMF facility and other multilateral inflows, coupled with strict controls on imports and profit repatriation, have helped Pakistan accumulate a small foreign exchange reserve, Moody’s notes “limited visibility” regarding the sources of financing for the country’s “very high external needs” after the current IMF Stand-By Arrangement concludes in a few weeks. The concern remains until Pakistan enters a new program with the IMF. The potential for Pakistan to transition from a high-risk to an investment-grade category hinges on the government undertaking durable structural reforms, ensuring political and policy stability.

In conclusion, Moody’s underscores the significance of a robust and sustained reform agenda for Pakistan’s economic trajectory. The looming uncertainty surrounding the new government’s capacity to swiftly negotiate a new IMF program raises concerns about default risks and continued financial challenges. Pakistan’s journey towards transitioning from a high-risk to an investment-grade category hinges on decisive structural reforms, political stability, and successful collaboration with international financial institutions.