Rating Action: Moody's places Pakistan's B3 rating under review for downgrade
4 May 2020
Singapore, May 14, 2020 -- Moody's Investors Service, ("Moody's") has today placed the Government of Pakistan's local and foreign currency long-term issuer and senior unsecured B3 ratings under review for downgrade.
The decision to place the ratings under review for downgrade reflects Moody's expectation that the government will request for bilateral official sector debt service relief under the recently announced G20 initiative. Suspension of debt service obligations to official creditors would be unlikely to have rating implications; indeed such relief would increase the fiscal resources available to the government for essential health and social spending due to the coronavirus outbreak.
However, the G20 has called on private sector creditors to participate in the initiative on comparable terms. Consistent with Moody's approach globally, the review period will allow the rating agency to assess whether Pakistan's participation in the initiative would likely entail default on private sector debt, notwithstanding the intended voluntary nature of private sector participation and the fact that the country has not, to Moody's knowledge, indicated interest in extending the debt service relief request to the private sector; and, if so, whether any losses expected to arise from that participation would be consistent with a lower rating.
The rapid spread of the coronavirus, sharp deterioration in global economic outlook, and significant reduction in risk appetite are creating a severe economic and financial shock. For Pakistan, the current shock transmits mainly through a sharp slowdown in economic activity, lower tax revenue as economic activity slows, and higher government financing needs relative to pre-coronavirus levels. However, ongoing reforms that pointed to nascent improvement in credit fundamentals before the outbreak and financing from development partners contain the pressure on the sovereign's liquidity and external positions.
Concurrently, Moody's has also placed the B3 foreign currency senior unsecured ratings for The Third Pakistan International Sukuk Co Ltd under review for downgrade. The associated payment obligations are, in Moody's view, direct obligations of the Government of Pakistan.
Pakistan's Ba3 local currency bond and deposit ceilings remain unchanged. The B2 foreign currency bond ceiling and the Caa1 foreign currency deposit ceiling are also unchanged. The short-term foreign currency bond and deposit ceilings remain unchanged at Not-Prime. These ceilings act as a cap on the ratings that can be assigned to the obligations of other entities domiciled in the country.
RATINGS RATIONALE / FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
RATIONALE FOR INITIATING THE REVIEW FOR DOWNGRADE
The driver for the review for downgrade is Moody's expectation that Pakistan will request bilateral debt service relief from G20 creditors under the recently announced initiative and the associated possibility of losses to private sector creditors.
The initiative offers benefits for the world's poorest nations, many of which have large external payment obligations and are exposed to outflows of capital and depreciating exchange rates during this unprecedented shock. Additional financial support and liquidity relief will allow fiscal resources to be devoted to essential health efforts and towards minimising the economic and social impact of the outbreak.
However, the G20 has called on private sector creditors to participate in the initiative on comparable terms. This suggests that, for the countries that elect to seek official sector debt service relief, the initiative may also lead to the suspension of payments or renegotiation of private sector debt service obligations. It is in this context that Moody's has placed Pakistan's ratings under review, in line with the rating agency's approach globally.
During the review period, Moody's will assess whether Pakistan's participation in the initiative will indeed be implemented without private sector participation, consistent with the intended voluntary nature of private sector participation, or whether any losses may be expected to arise for private sector creditors that would be consistent with a lower rating. Pakistan has not indicated any interest in extending the debt service relief to include private sector creditors.
At this stage, Moody's assesses that the main impact of the coronavirus shock is on Pakistan's economic growth, which raises fiscal challenges and delays the government's fiscal consolidation and debt reduction efforts. Ongoing and significant financial and technical support from development partners, as well as the effective use of monetary policy, mitigate the impact of the shock on the sovereign's liquidity and external positions.
The Pakistani economy is relatively closed, with low reliance on exports and private capital inflows and limited trade linkages. However, the coronavirus outbreak presents a significant shock to the domestic economy in part due to the measures aimed at restricting the movement of people to prevent the spread of the virus. Moody's expects Pakistan's economy to contract by around 1% in fiscal 2020 (ending June 2020), and to grow by 2-3% in fiscal 2021 -- below potential.
The economic slowdown will weigh on government revenue and modestly raise spending, in turn pushing the fiscal deficit wider to close to 10% of GDP in fiscal 2020. As a result, Moody's projects the government's debt burden to reach around 85-90% of GDP in fiscal 2020. However, the government's commitment to fiscal reforms, including under its 2019-22 International Monetary Fund programme, provides a crucial anchor for the continued expansion of its revenue base when economic activity gradually normalises. Overall, Moody's expects that the debt burden will return to a downward trend after the initial shock.
The macroeconomic adjustments that have occurred over the past 18-24 months have also reduced external vulnerability risks in the face of a potentially significant shock. Moody's projects the current account deficit to be relatively narrow, around 2% of GDP in this and the next fiscal year, as lower goods and oil imports offset a fall in remittances inflows. Combined with financing inflows from multilateral and bilateral official lenders, the balance of payments is likely to be broadly stable, containing pressure on the exchange rate. In turn, a stable balance of payments will likely allow the State Bank of Pakistan, the central bank, some scope to provide monetary accommodation, which will help contain the government's interest payments. Risks remain on the downside should external pressure be more severe than Moody's currently assesses, whether because the current account widens materially and/or because some external financing looks less secure than the rating agency currently anticipates.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
Environmental considerations are significant to Pakistan's credit profile because it is vulnerable to climate change risk. Pakistan is significantly exposed to extreme weather events, including tropical cyclones, drought, floods and extreme temperatures. In particular, the magnitude and dispersion of seasonal monsoon rainfall influence agricultural sector growth and rural household consumption. The agricultural sector directly accounts for around 20% of GDP and exports, and nearly 40% of total employment. As a result, both droughts and floods can create economic, fiscal and social costs for the sovereign.
Social considerations are material to Pakistan's credit profile. Access to quality healthcare, education and utilities such as electricity and water remains limited, especially in rural areas, although the government is addressing these issues as a key priority through its "Ehsaas" programme that is aimed at reducing poverty and inequality, strengthening social safety nets and promoting human capital development. Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. For Pakistan, the epidemic exposes the challenge to the government in enhancing healthcare and public services provision.
Governance considerations are significant to Pakistan's credit profile. International surveys of various indicators of governance, while showing some early signs of improvement, point to weak rule of law and control of corruption, as well as limited government effectiveness. These weaknesses are balanced against a lengthening track record of effective checks and balances and judicial independence for the level of development in the country.
WHAT COULD LEAD TO A CONFIRMATION OF THE RATING AT THE CURRENT LEVEL
The rating would likely be confirmed at its current level should Moody's conclude that participation in bilateral official sector debt service relief would unlikely entail default on private sector debt or, if it would, that any losses experienced would likely be minimal.
Upon conclusion of the review, and under a scenario of no or minimal loss for private sector creditors, expectations that government financing, debt sustainability, and external vulnerability risks are contained would likely be consistent with a stable outlook at B3.
WHAT COULD CHANGE THE RATING DOWN
The rating would likely be downgraded should Moody's conclude that participation in the G20 debt service relief initiative would probably entail default on private sector debt and that losses experienced would likely exceed the threshold consistent with a B3 rating.
Downward pressure on the rating would also stem from a renewed and material deterioration in Pakistan's external position, including through a significant widening of the current account deficit and erosion of foreign exchange reserve buffers, which would threaten the government's external repayment capacity and heighten liquidity risks. A continued rise in the government's debt burden, without prospects for stabilisation over the medium term, would additionally put downward pressure on the rating.
GDP per capita (PPP basis, US$): 5,872 (2019 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 3.3% (2019 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 8.0% (2019 Actual)
Gen. Gov. Financial Balance/GDP: -8.9% (2019 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -4.8% (2019 Actual) (also known as External Balance)
External debt/GDP: 37.9% (2019 Actual)
Economic resiliency: ba2
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 11 May 2020, a rating committee was called to discuss the rating of the Pakistan, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.