Pakistan’s long term default ratings placed at stable outlooks: Fitch Ratings
HONG KONG: Fitch Ratings has affirmed Pakistan’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘B’ with Stable Outlooks.
The issue ratings on Pakistan’s senior unsecured foreign- and local-currency bonds, Country Ceiling as well as the Short-Term Local- and Foreign-Currency IDRs and are also affirmed at ‘B’.
The issue ratings on The Third Pakistan International Sukuk Company Limited’s foreign-currency global certificates have also been affirmed at ‘B’.
The company was incorporated primarily for the purpose of facilitating sukuk transactions and is wholly owned by Pakistan.
KEY RATING DRIVERS
Pakistan’s ratings balance broad gains achieved over the International Monetary Fund (IMF) programme against a high public debt/GDP ratio, low scores on the World Bank governance indicators and heightened security risks.
Pakistan completed a three-year IMF Extended Fund Facility (EFF) in September 2016.
The country has entered 12 IMF programmes since 1988, but this the first programme that it has completed. Under the program, reserves were strengthened, the fiscal deficit reduced and significant progress was made on structural reform.
Pressure related to the 2018 elections could test the government’s commitment to maintaining the policy framework set out by the IMF.
The country’s economic outlook has brightened since the start of the programme, with annual GDP growth rising to 4.7% in the financial year ending June-2016 (FY16), from 3.7% in FY13, above the ‘B’ median of 3.6%.
Fitch expects growth to strengthen to 5.3% in FY17, lifted by a recovery in agricultural output following poor weather conditions in the previous season and an influx of investment linked to the China-Pakistan Economic Corridor (CPEC).
“We forecast continued strong domestic demand, with private consumption aided by faster credit growth. Remittances have moderated, as over half come from Gulf economies that are adjusting to lower energy prices, but a sharper slowdown is a downside risk.
A sharp slowdown in remittances is a downside risk, as over half come from Gulf economies that are still adjusting to lower energy prices. Inflation slowed to 2.9% in FY16, a positive development for a country that has experienced higher and more volatile inflation than the ‘B’ median,” the rating agency said.
Fitch expects inflation to increase to 4.5% in FY17 and 4.8% in FY18, as commodity prices slowly recover. Inflation is then forecast to remain stable in the medium term.
Central bank financing of the fiscal deficit is an upside risk to inflation; government borrowing is shifting back towards the State Bank of Pakistan after moving towards private banks under the IMF programme.
The banking sector has performed well, with improvements shown across IMF’s Financial Soundness indicators. Non-performing loans remained high at 11.1% of total loans at FYE16, though this is down from a peak of 14.8% at end-June 2013.
Pakistan’s public debt/GDP ratio of 64.8% at end-FY16 was higher than the ‘B’ median of 56.7%, but Fitch expects the ratio to gradually fall in the medium-term if the country can sustain its progress with fiscal consolidation.
The general government budget deficit fell to 4.6% of GDP in FY16, from 5.3% in FY15, with revenues boosted by structural reforms, including the lowering of the number of tax concessions.
Fitch projects the budget deficit to continue narrowing gradually if the economy performs in line with our baseline scenario and the government remains committed to the policy plans set out during the IMF programme.
The accumulation of losses in public sector enterprises (PSE), particularly electricity distribution companies, has in the past lead to injections of funds from the federal government budget to clear debt.
Efficiency improvements, higher tariffs and lower energy prices have helped cut PSE losses. However, plans to sustain long-term efficiency gains through privatisation have been delayed due to objections from workers and political opposition.
PSE losses could rise considerably if Pakistan suffers an economic shock or there is a sharp rise in energy prices, ultimately feeding through to the government balance sheet.
“We do not expect Pakistan to face external liquidity difficulties in our baseline scenario, but increasing gross external financing needs could increase the country’s vulnerability to shifts in investor sentiment. External debt service costs are likely to increase in the medium-term, with USD2.75bn of international bonds maturing between FY17 and FY20,” Fitch said.
The country will also start paying back the USD6.4bn IMF facility and USD11.7bn of rescheduled Paris Club debt in FY18 and FY17, respectively, albeit over an extended timeframe.
Fitch also expects the current account deficit to widen as energy prices start to recover and capital imports increase with higher infrastructure investment, although such investments will be heavily funded by Chinese entities as part of the CPEC.
Pakistan demonstrated market access in October 2016 by issuing a USD1bn sukuk at an historically low yield of 5.5%. Geopolitical tension and security threats could negatively affect the economic outlook and investor sentiment.
Pakistan has had a series of disagreements with India in 2016 over violent incidents along the shared border, marking a turn in relations that had shown tentative signs of improvement in the previous two years.
Domestic terrorist incidents remain frequent, particularly in Balochistan province and along the Afghanistan border, although the number of attacks fell in 2016 compared with the previous year, and annual civilian casualties from terrorist activities are at the lowest point since 2006.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Pakistan a score equivalent to a rating of ‘B+’ on the Long-Term Foreign-Currency IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows: – Structural factors: -1 notch, to reflect domestic security threats and geopolitical risks arising from tension with neighbouring countries.
Pakistan also has a low rank on the World Bank’s Ease of Doing Business index relative to ‘B’ rated peers, despite a small improvement in 2017. Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR.
Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable or are not fully reflected in the SRM.
The main factors that could, individually or collectively, lead to positive rating action are:
– Sustained fiscal consolidation, strengthening of the revenue base, lower government debt ratios and smaller contingent liabilities from state-owned entities.
– Progress with structural reforms that lead to an improved business environment, stronger economic growth and higher investment. – A better security situation and decreased political risk.
The main factors that could, individually or collectively, lead to negative rating action are:
– Policy slippage that leads to renewed pressure on economic and financial stability, which may be evident in a rapid loss of reserves or a sharp rise in inflation.
– Deterioration in the fiscal position that leads to a sharp or sustained rise in government debt ratios, including contingent liabilities from state-owned entities.
– Fitch’s economic base case assumes Pakistan’s economic policy framework remains broadly unchanged over the political cycle.
– The ratings incorporate an assumption that Pakistan’s relations with India do not deteriorate to the point of renewed armed conflict.
– The global economy is presumed to perform broadly in line with Fitch’s latest Global Economic Outlook report.