Moody's Investors Service has today downgraded Pakistan's foreign- and local-currency bond ratings by one notch to Caa1 from B3. The short-term ratings remain unchanged at Not-Prime. The outlook is negative.
Moody’s said the key drivers for today's rating action are:
· A deterioration in Pakistan's balance of payments over the past year
· The looming large repayments to the International Monetary Fund (IMF)
· The dwindling level of official foreign-exchange reserves
· The institutional weakness stemming from political instability and
constrained government finances
Moody's has also revised Pakistan's country ceilings as follows: the foreign-currency country ceiling to B3 from B1, the foreign-currency deposit ceiling to Caa2 from B3, and the local-currency bond and deposit ceilings to B1 from Baa2 and Ba2, respectively. The considerable change in the local-currency ceilings reflects a downward assessment of Institutional Strength to 'very low' from 'low' in our assessment of sovereign risk.
As reflected by the negative outlook on Pakistan's Caa1 government bond rating, Moody's considers an upgrade very unlikely over the medium term.
A combination of factors would prompt Moody's to consider a further downgrade. These include a substantial worsening of the domestic political environment and significant further deterioration in the policy framework and investor confidence. More specifically, a continued sizable decline in official foreign-exchange reserves, from whatever causes—such as from a deterioration in the global demand for Pakistan's goods and labor exports or from domestic political paralysis or policy choices—would be strongly credit-negative as the probability of default would increase materially.
Moody's said the main driver for its one-notch downgrade of Pakistan's government bond ratings is the increasing strain on the country's external payments position as a result of a rising trade deficit and decline in capital inflows. Moreover, it said weak government finances, structural inflationary pressures and domestic political uncertainties are adding to Pakistan's external vulnerabilities and debt sustainability, thereby compounding the downward pressure on sovereign creditworthiness.
“While Pakistan recorded a small current account surplus in fiscal year 2010-11, the country's current account reverted to a deficit of US$3.8 billion during the period from July 2011 to May 2012. The reason for the reversal in the current account balance lies primarily in the stalled export growth recorded in the eleven months — in contrast to a significant 28.9% expansion in fiscal year 2010-11— due to the collapse in demand from Europe, Pakistan's main export market, and weakening cotton prices, “ Moody’s explained.
In addition to the deteriorating current account deficit, Moody's also expects the country's capital account to exert further pressure on the balance of payments. Foreign direct investment (FDI) has been on a secular decline since the US$5.4 billion inflow in 2008. Based on recent trends, Moody's expects that FDI will fall short of US$1 billion in 2012. At the same time, Pakistan's import bill, a significant portion of which consists of subsidized petroleum products, remains sensitive to global oil price developments.
While Moody's recognizes that worker remittance inflows have provided much support to Pakistan's balance of payments and domestic economy (having increased 11.9% to $15.9 billion in the July 2011-May 2012 period from the same period a year earlier), the rating agency also notes that recent data suggests that growth in such inflows is tapering off.
Moreover, in view of the gloomy global economic outlook, Moody's does not consider an improvement in Pakistan's current account to be likely over the near term.
The large upcoming repayments to the International Monetary Fund (IMF) represent the second driver underlying Moody's decision to downgrade Pakistan's sovereign creditworthiness.
Pakistan has approximately US$7.5 billion in principal and interest falling due to the IMF in 2012, 2013, 2014 and 2015. Pakistan has repaid $1.2 billion of that amount as of June, but this still leaves sizable repayments mostly in 2013 and 2014. Additional pressure on the balance of payments stems from the government's decision to terminate its stand-by arrangement with the IMF in November 2011.
The third driver of the downgrade is Pakistan's dwindling level of official foreign-exchange reserves, which have declined steadily after reaching an historical peak of US$16.8 billion in July 2011. This weakening in Pakistan's external payments position, a direct upshot of the deterioration in Pakistan's balance of payments, raises the probability of a default over the next year or two. As of the end of June, the Central Bank of Pakistan's gross international liquidity, including IMF SDR holdings, had fallen to about US$12.4 billion (foreign-exchange reserves alone were US$10.8 billion at the end of June). The amount of repayments that are due to the IMF in 2013 and 2014 alone are equivalent to almost half of the central bank's current reserve holdings.
Moody’s observed: “Although official foreign exchange reserves are currently more than adequate to cover all payments falling due on both long- and short-term external debt in the year ahead, continued deterioration in current account, coupled with a lack of equity or portfolio investment inflows or a bout of capital flight, would eventually undermine reserve adequacy. In particular, the absence of an IMF financial support programme, or in the absence of augmented and predictable financial support from foreign governments or multilateral development banks, would most likely lead to a more rapid decline in reserves in the year ahead.”
It notes that the frayed relations between Pakistan and the US was very recently mended to some degree, at least for now, as the US agreed to resume disbursement of suspended Coalition Support Funds.
Lastly, the fourth driver of Moody's rating action is the factious relationship between Pakistan's elected political leaders, the judiciary and the military, which undermines the government's ability to formulate policies to address the country's pressing domestic economic challenges, to bolster investor confidence and to attract much needed external financial support from official creditors and donors. In addition, the strained condition of Pakistan's public-sector finances and weak institutional features resulted in the recent default (in May 2012) by the government-owned Central Power Purchasing Agency on arrears to the private independent power producers, the payments of which were guaranteed by the government.
The Asset - Magazine-Moody's downgrades Pakistan's government bond ratings to Caa1, outlook negative
