Pakistan Rating Lowered To 'B-' With Weaker Prospects For External, Fiscal Recovery; Outlook Stable


RATINGS

Foreign Currency: B-/Stable/B
Local Currency: B-/Stable/B 
For further details see Ratings List.


OVERVIEW
  • Pakistan's economic outlook, as well as its external position, have deteriorated well beyond our previous expectations. With the weaker economic settings, and limited progress in addressing fiscal imbalances following elections in mid-2018, we believe prospects for a rapid recovery in fiscal and external settings are now diminished.
  • More modest growth prospects and limited reserve buffers will continue to challenge the country's external position, even as the government receives financial aid from various partners. Negotiations with the IMF have taken longer than anticipated, and we now believe the reform timeline will be more protracted in nature.
  • We are lowering our long-term sovereign credit rating on Pakistan to 'B-' from 'B' on the diminished growth prospects, as well as elevated external and fiscal stresses. At the same time, we are affirming our 'B' short-term sovereign rating.
  • The stable outlook reflects our expectations that Pakistan will secure sufficient funding to meet its external obligations in the next one to two years.
SINGAPORE (S&P Global Ratings) Feb. 4, 2019—S&P Global Ratings today lowered 
its long-term sovereign credit rating on Pakistan to 'B-' from 'B'. The 
outlook for the long-term rating is stable. At the same time, we affirmed the 
short-term sovereign rating and issue rating at 'B'. We also lowered the 
long-term issue rating on senior unsecured debt and sukuk trust certificates 
to 'B-' from 'B'.

OUTLOOK
The stable outlook reflects our expectations that Pakistan will secure 
sufficient financing to meet its external obligations over the next 12 months, 
and that neither external nor fiscal metrics will deteriorate well beyond our 
current projections.

We may raise our ratings on Pakistan if the economy materially outperforms our 
expectations, strengthening the country's fiscal and external positions. 

Conversely, we may lower our ratings if Pakistan's fiscal, economic, or 
external indicators continue to deteriorate, such that the government's 
external debt repayments come under pressure. Indications of this would 
include GDP growth below our forecast, or external or fiscal imbalances higher 
than what we expected.

RATIONALE
We lowered the ratings to reflect our more subdued expectations for Pakistan's 
economic growth, along with heightened external and fiscal risks, amid an 
ongoing deterioration in the country's broad macroeconomic settings. While 
Pakistan has secured financial aid from bilateral partners to address its 
immediate external financing needs, we believe that fiscal and external 
imbalances will remain elevated. The government's protracted negotiations with 
the International Monetary Fund (IMF) suggest that any resulting reforms, 
whether under the program or otherwise, will be less expedient than previously 
anticipated.  

Fiscal consolidation will be challenging as the economy slows owing to a 
paucity of growth drivers, and as the stimulus from China-Pakistan Economic 
Corridor (CPEC) investment fades. Although we believe Pakistan will benefit 
over the long term from the associated improvements to its infrastructure, 
this will be counterbalanced by heightened fiscal and external stresses over 
the next few years. 

In our opinion, the government led by Pakistan Tehreek-e-Insaf (PTI) party has 
yet to introduce fiscal measures that are sufficient to bring about a 
substantial improvement in the general government deficit. Though the 
government in October 2018 introduced new budget measures that will increase 
revenue from petroleum products and infrastructure development, among others, 
we believe that additional measures would be necessary in order to bring about 
a more meaningful decline in the fiscal deficit. The second mini-budget 
presented in January should be marginally supportive of the economy, but is 
unlikely to have a significant impact on fiscal imbalances. Relative to our 
previous expectations, we now believe prospects for a broader stabilization of 
Pakistan's credit metrics have diminished. 

The ratings on Pakistan remain constrained by a narrow tax base and domestic 
and external security risks, which continue to be high. Although the country's 
security situation has gradually improved over the recent years, ongoing 
vulnerabilities weaken the government's effectiveness and weigh on the 
business climate.


Institutional and economic profile: Change in government yet to yield serious 
reform push 
  • Although Pakistan's new government has publicly acknowledged the necessity of economic and fiscal reform, progress has been slower than anticipated.
  • Pakistan's very low income level remains a rating weakness.
  • Inadequate infrastructure and security risks continue to act as structural impediments to foreign direct investment and sustainable economic growth.
The 2018 general elections have thus far not elicited a significant 
improvement in Pakistan's economic environment. Despite acknowledgment by 
senior administration officials that Pakistan must embrace hard-hitting 
economic and fiscal reforms to avert a balance of payments and broader 
economic crisis, we believe that imbalances will remain elevated over the next 
two years. Although no single party earned a majority of the votes in July 
2018's general elections, the PTI's leading vote share was sufficient to 
propel party chairman Imran Khan to the post of prime minister in the newly 
formed coalition government. 

Pakistan is facing considerable external and fiscal pressure following a 
significant rise in both the general government fiscal and current account 
deficits in the fiscal year ended June 2018. These metrics have deteriorated 
since the completion of an Extended Funding Facility (EFF) reform program with 
the IMF in September 2016, leading the current government to seek financial 
and technical assistance from a variety of bilateral and multilateral parties. 
Against our previous expectations, we now believe that these difficulties will 
persist for some time, and that key metrics will worsen further through 2019. 

In order to meet the economy's elevated external funding needs, the government 
has reportedly secured foreign exchange support of approximately US$3 billion 
each from the United Arab Emirates (UAE) and Saudi Arabia, along with deferred 
payments of US$3.2 billion from each country for 2019 oil imports. These funds 
will help to alleviate acute external stresses and to supplement the central 
bank's limited foreign exchange reserves. 

Nevertheless, negotiations with the IMF for additional funding, potentially 
under the auspices of a new EFF program, have yet to deliver tangible results. 

We estimate Pakistan's GDP per capita at just over US$1,500 in 2018, which is 
in the bottom 10% of all sovereigns rated by S&P Global Ratings. We have 
revised downward our forecast of annual real GDP growth to an average 3.6% 
over 2019-2022. Pakistan's per capita GDP growth is somewhat lower, at about 
1.5%, due to a fast-growing population. Our weaker growth projections mainly 
reflect the diminishing stimulatory impact of the investments associated with 
the CPEC, negative fiscal impulse as the government looks to rein in its 
deficit, and declining economic sentiment. Although we believe CPEC energy 
projects such as coal, solar, hydroelectric, liquefied natural gas, and power 
transmission will be supportive toward economic activity over the long run, 
this effect is unlikely to sufficiently offset the loss in momentum in the 
economy during this period of acute fiscal and external stress. 

Growth will also be constrained by domestic security challenges and 
long-lasting hostility with neighboring India and Afghanistan. These 
conditions, along with inadequate infrastructure, mainly in transportation and 
energy, are additional bottlenecks to foreign direct investments. The former 
PML government improved the security situation, and we would expect the PTI 
government to continue this positive momentum. Although progress has been made 
toward addressing these shortcomings, we believe there is much more to be done 
before we can see considerable uplift to the business climate.

Flexibility and performance profile: Deterioration in key metrics to continue 
through 2019 
  • Infrastructure investments and energy vulnerabilities have contributed to a significant weakening in external metrics.
  • Pressure on external accounts will rise further in 2019.
  • We forecast net general government debt to rise toward 70.2% of GDP by the end of fiscal 2022, with slower GDP growth and still-elevated deficits. Likewise, Pakistan's interest-servicing burden will remain elevated, at an average of 32.4% of revenues.
Over the near term, deferred payments on oil imports from the UAE and Saudi 
Arabia, with an estimated total value of US$6.4 billion, will help to smooth 
pressing external financing needs. But more will need to be done to stem this 
vulnerability over the medium term, especially on export promotion and energy 
security. Pakistan's current account deficit widened again to 6.1% of GDP in 
the fiscal year ended June 2018, from 4.1% the year before and just 1.7% in 
2016. The widening of the deficit was due to a strong rise in imports, without 
a correspondingly high growth in exports, with higher energy prices and the 
associated deterioration in Pakistan's terms of trade exacerbating the 
shortfall in the current account deficit. Remittances were roughly flat for 
the second year in a row in 2018, exhibiting limited upside despite a 
stabilization in the Gulf countries.

Although we expect the current account deficit to decline somewhat over the 
next two years with energy prices falling and the economy slowing, Pakistan's 
external financing and indebtedness metrics remain stressed. Pakistan's high 
degree of external stress is marked by a significant rise in the economy's 
gross external financing needs relative to its current account receipts and 
useable reserves; we forecast this ratio will climb to 151.1% at the end of 
fiscal 2019, versus approximately 131% in the previous year. Meanwhile, we 
project the country's narrow net external debt will rise to more than 170% of 
current account receipts, from just below 140% in the prior year. Though 
external aid will help to meet immediate payment needs, indebtedness will 
continue to rise in kind.

Pakistan's fiscal profile has deteriorated beyond our previous expectations, 
and we have yet to observe policy initiatives sufficient to meaningfully 
reverse this trend. Change in net general government debt rose to 9.4% in 
fiscal 2018 versus 5.6% in the previous year, largely owing to the 
government's higher fiscal deficit and the depreciation of the Pakistani 
rupee. 

Although the new government has elucidated its aim to consolidate its fiscal 
accounts, we believe progress will be diminished by political constraints, 
especially in view of more difficult economic circumstances. Meanwhile, 
negotiations with the IMF to secure a funding and aid package have been 
protracted. We now anticipate that any resulting reforms, whether under a 
program or otherwise, will be less expedient in addressing the country's 
economic imbalances. We forecast the average annual change in net general 
government debt at 5.9% of GDP through 2022, which is elevated versus our 
previous expectations. 

Coupled with our lower expectations for real GDP growth, the forecast fiscal 
deficits will entail a gradual rise in net general government indebtedness 
toward just above 70% of GDP by the end of 2022. 

Pakistan's unusually high level of interest expense relative to fiscal revenue 
is an additional constraint on our assessment of the government's debt burden. 
Interest expense consumes nearly a third of government revenue, partly a 
function of its narrow tax base. Pakistan's ratio of tax revenue to GDP 
remains one of the lowest among sovereigns that we rate.

Pakistan's banking system is relatively small by international standards, with 
total bank assets comprising approximately 59% of GDP. We do not have a 
Banking Industry Country Risk Assessment on Pakistan. However, its banking 
system appears stable, reflecting its high profitability, adequate liquidity, 
and strong capitalization. Combining our view of Pakistan's government-related 
entities and its financial system, we assess the country's contingent fiscal 
risks as limited. That said, at more than 20% of total system assets, 
Pakistan's banking system bears an outsized exposure to the sovereign. 

We believe the State Bank of Pakistan's (SBP) autonomy and performance has 
strengthened since the setup of a monetary policy committee for rate setting 
in January 2016. The SBP's interest rate corridor helps the monetary 
transmission mechanism by providing directions for short-term market interest 
rates. This framework, combined with the cyclical boost from lower food and 
energy prices, should keep inflation in check--averaging about 5.5% over our 
forecast horizon. Reduced budget financing by the SBP would also assist in 
cutting inflationary pressure.

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