Hong Kong July 29 2024: Fitch Ratings has upgraded Pakistan’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CCC+’ from ‘CCC’. Fitch typically does not assign Outlooks to sovereigns with a rating of ‘CCC+’ or below.
The upgrade reflects greater certainty over continued availability of external funding, in the context of Pakistan’s staff-level agreement (SLA) with the IMF on a new 37-month USD7 billion Extended Fund Facility (EFF). Strong performance on the previous, more temporary IMF arrangement helped the country narrow fiscal deficits and rebuild foreign exchange (FX) reserves, and further improvements are likely. Nevertheless, Pakistan’s large funding needs leave it vulnerable if it fails to implement challenging reforms, which could undermine programme performance and funding.
Pakistan and the IMF reached the SLA on 12 July. Before IMF Board approval, which we assume by end-August, the government will have to obtain new funding assurances from bilateral partners, chiefly Saudi Arabia, the UAE and China, totalling about USD4 billion-5 billion over the duration of the EFF. We believe this will be achievable, given the strong past record of support and significant policy measures in the recent budget for the fiscal year ending June 2025 (FY25).
The government aims under the new EFF to tackle longstanding 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 targets a 3pp increase in tax revenues/GDP, from under 9% in FY24, including through higher taxes on the country’s influential agricultural sector, which will have to be legislated at the provincial level.
Pakistan successfully completed its nine-month Stand-by Arrangement with the IMF in April. Over the past year, the government raised taxes, cut spending and raised electricity, gas and petrol prices. The government also all but eliminated the gap between the interbank and parallel market exchange rates through a crackdown on the black market and regulation of exchange houses.
We forecast the current account deficit (CAD) to stay relatively contained at about USD4 billion (about 1% of GDP) in FY25, after about USD700 million in FY24, given tight financing conditions and subdued domestic demand. Contractionary economic and fiscal policies, lower commodity prices and rupee depreciation have driven the sharp narrowing of the CAD from over USD17 billion in FY22. FX shortages have eased with the return of remittances to the official banking system, reversing their decline in 2H22.
Besides CADs, the authorities face over USD22 billion in external public debt maturities in FY25. Of the total maturities, USD13 billion is in the form bilateral deposits and loans that are regularly rolled over, including nearly USD4 billion in liabilities of the State Bank of Pakistan (SBP). Maturing debt also includes nearly USD4 billion from Chinese commercial banks, and USD4 billion from multilateral creditors. Pakistan’s next international bond maturity is in September 2025.
The government says it has identified over USD24 billion in gross external financing, mostly from bilateral and multilateral sources, not including potential bond issuance or the renewal of the oil facility with Saudi Arabia, but including a potential Panda bond issuance. FDI and non-resident portfolio inflows and climate-related finance pose other upsides to the funding plan.
The SBP is rebuilding FX reserves amid inflows of new funding and limited CADs. We estimate official gross reserves, including gold, rose to over USD15 billion at June 2024 (about three months of imports), from nearly USD10 billion at end-June 2023, and we expect them to rise to nearly USD22 billion by FYE26, close their 2021 peak.
The SBP’s narrower measure of net liquid FX reserves (excluding gold and FX reserve deposits of banks) recovered to over USD9 billion at June 2024. The SBP has reduced its forward liabilities to local banks and is approaching a balanced net foreign asset/liability position.
Half of the revenue effort under the EFF is frontloaded in the FY25 budget, which was prepared together with IMF staff and projects a headline deficit of 5.9% of GDP and a 2.0% primary surplus (FY24 estimate: 7.4% and 0.4%, respectively). Our forecasts assume partial implementation of this and project a primary surplus of 0.8% of GDP and an overall fiscal deficit of 6.9% of GDP in FY25, improving to 1.3% of GDP and 6% of GDP, respectively, in FY26. Besides tax measures, the budget assumes a doubling of SBP dividends to 2% of GDP, and a doubling of provincial surpluses to 1% of GDP.
