Moody’s changes Pakistan’s outlook to stable and India’s to negative

KARACHI:Moody’s Investors Service has upgraded Pakistan’s credit rating outlook to stable from negative, signalling further improvement in foreign currency inflows into the country. Moreover, the rating agency downgraded India's outlook to negative from stable.

Moody’s also affirmed the government of Pakistan’s local and foreign currency long-term issuer and senior unsecured debt ratings at B3.

“The change in outlook to stable is driven by Moody’s expectations that the balance of payments dynamics will continue to improve, supported by policy adjustments and currency flexibility,” read a Moody’s report released on Monday.

“Such developments reduce external vulnerability risks, although foreign exchange reserve buffers remain low and will take time to rebuild.”

Moody’s said the recent currency depreciation has pushed up Pakistan’s debt level and weakened Islamabad’s fiscal strength.

However, the credit agency said that “the ongoing fiscal reforms, including through the country’s International Monetary Fund (IMF) programme, will mitigate risks related to debt sustainability and government liquidity.”

“The rating affirmation reflects Pakistan’s relatively large economy and robust long-term growth potential, coupled with ongoing institutional enhancements that raise policy credibility and effectiveness, albeit from a low starting point,” read the report.

“Moody’s expects Pakistan’s current account deficit to continue narrowing in the current and next fiscal year (ending June of each year), averaging around 2.2% of GDP, from more than 6% in fiscal 2018 (the year ending June 2018) and around 5% in fiscal 2019.

“Under Moody’s baseline assumptions, subdued import growth will likely remain the main driver of narrowing current account deficits. In particular, the ongoing completion of power projects will reduce capital goods imports, while oil imports will remain structurally lower given the gradual transition in power generation away from diesel to coal, natural gas and hydropower.

“Currently tight monetary conditions and import tariffs on nonessential goods will also weigh on broader import demand for some time, although Moody’s sees the possibility of monetary conditions easing when inflation gradually declines towards the end of the current fiscal year.

“Moody’s expects exports to gradually pick up on the back of the real exchange rate depreciation over the past 18 months, also contributing to narrower current account deficits.

“The government is focusing on raising the country’s trade competitiveness and has recently rolled out a National Tariff Policy aimed at incentivising production for exports or import substitution.

“If effective, the policy, coupled with improvements in the terms of trade, will allow exports to grow more robustly. The substantial increase in power generation capacity over the past few years and improvements in domestic security have largely addressed two significant supply-side constraints and further support export-related investment and production.

“Moody’s expects policy enhancements, including strengthened central bank independence and the commitment to currency flexibility, to support the reduction in external vulnerability risks.

“In particular, the government is planning to introduce a new State Bank of Pakistan (SBP) Act to forbid central bank financing of government debt and clarify SBP’s primary objective of price stability.

“These enhancements to the policy framework will foster confidence in the Pakistani rupee, while the use of the exchange rate as a shock absorber increases policy buffers.

“Notwithstanding improved balance of payments dynamics, Pakistan’s foreign exchange reserve adequacy remains low. Foreign exchange reserves have fluctuated around $7-8 billion over the past few months, sufficient to cover just 2-2.5 months of goods imports.

“Coverage of external debt due also remains low, with the country’s External Vulnerability Indicator — which measures the ratio of external debt due over the next fiscal year to foreign exchange reserves — remaining around 160-180%.

“The IMF programme, which commenced in July 2019, targets higher foreign exchange reserve levels and has unlocked significant external funding from multilateral partners including the Asian Development Bank and the World Bank.

“Nevertheless, unless the government can effectively mobilise private sector resources, foreign exchange reserves are unlikely to increase substantially from current levels.”

The report also included a rationale for Pakistan’s rating approval.

“The affirmation of Pakistan’s B3 rating is underpinned by the country’s relatively large economy and robust growth potential, coupled with ongoing enhancements to the institutional and policy framework that raise policy credibility and effectiveness, albeit from a low starting point.

Pakistan’s economy is among the largest across similarly rated peers, while we estimate its growth potential to be around 5%, higher than the median for B3 rated sovereigns.”

The report further outlines scenarios for upward or downward changes in Pakistan’s credit rating. “Upward pressure on Pakistan’s rating would develop if ongoing fiscal reforms were to raise the government’s revenue base and debt affordability, and lower its debt burden markedly beyond Moody’s current expectations.

“Further reduction in external vulnerability risks, including through higher levels of foreign exchange reserve adequacy and/or increased economic competitiveness that were to lift export prospects, would also put upward pressure on the rating.

“Downward pressure on the rating would stem from renewed 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.