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KEY RATING DRIVERS
Pakistan's 'B-' rating reflects weak public finances, external finance vulnerabilities, and low governance indicator scores. The authorities have made progress in addressing external and public finance challenges over the past few years, despite the headwinds from the Covid-19 pandemic. However, economic uncertainties from the pandemic and political challenges to keeping the reform agenda on track pose risks.
A decline in external vulnerabilities has been facilitated by adherence to a market-determined exchange-rate regime, which has served as a shock absorber during the pandemic. Progress towards institutionalising this framework, if sustained, should limit medium-term risks by keeping current account deficits contained and reducing foreign-exchange (FX) reserve pressures.
External inflows have supported an appreciation of the Pakistan rupee against the US dollar and a further rebuilding of FX reserves. Fitch forecasts that official FX reserves (excluding gold) will reach USD17.4 billion (3.2 months of current external payments; 2021 B median: 4.7 months) by the end of the fiscal year to June 2021 (FY21) from USD13.3 billion at FYE20. Under our baseline, reserves are expected to rise to USD22.3 billion by FYE22, including a planned USD2.8 billion boost from the IMF's special drawing rights allocation.
We project that Pakistan's current account deficit will narrow to 0.5% of GDP in FY21, from 1.7% in FY20, due to a surge in remittance inflows, import compression, and low average oil prices. Remittance growth averaged nearly 30% yoy in FY21, reflecting a shift from informal to formal remittance channels and an underlying increase in transfers from non-resident Pakistanis. Export growth, which is key to medium-term external sustainability, has also picked up, but from low levels. We forecast a widening of the current account deficit to 1.9% of GDP in FY22 as the recovery in domestic demand and higher oil prices push imports higher.
External debt repayments will remain high, at about USD8 billion-10 billion per annum over the next few years. Participation in the G-20's Debt Service Suspension Initiative (DSSI) has reduced near-term pressures by postponing USD3.7 billion in payments previously scheduled between May 2020 and December 2021 to over a five- to six-year period.
Access to external financing from multilateral, bilateral and private sources has been sustained, facilitated by the government's policy reforms and continued progress in meeting conditions under the Extended Fund Facility (EFF) programme with the IMF. Pakistan's March 2021 Eurobond issue of USD2.5 billion had strong investor demand. China remains a key source of bilateral financing, providing about USD2.3 billion in budget support in FY21, and augmenting the size of the People's Bank of China's Currency-Swap Agreement with the State Bank of Pakistan (SBP), the central bank, by USD1.5 billion, which was used to help repay USD2 billion in deposits from Saudi Arabia in FY21.
Approval of the EFF's second-to-fifth reviews by the IMF board in March unlocked a USD500 million disbursement, marking the resumption of the programme after a pause for much of the last year due to disruptions from the pandemic. Fitch understands that negotiations for the sixth review have commenced, which are centred around the FY22 budget. We believe that completion of the review within the current June timeframe could prove challenging given divergent views over the timing and pace of tax revenue measures and energy tariff increases, as well as the appointment of a new Minister of Finance in April. However, both the government and the IMF appear committed to the programme's ultimate objectives.
Public finances remain a key weakness for the sovereign. We project the general government fiscal deficit will narrow slightly to 7.5% of GDP in FY21 (B median: 6.2% deficit), from 8.1% in FY20, as revenue growth has been resilient due to tax administration improvements and the growth rebound. We forecast a further narrowing to 6.6% of GDP on improving revenue and declining expenditure. We expect the upcoming budget to focus on enhancements to tax administration and potentially new revenue measures. The government interest burden as a share of revenue is high, at a Fitch-estimated 38.7% in FY21 (B median: 12.5%), and the narrow revenue base remains a challenge for fiscal sustainability.
We project Pakistan's debt-to-GDP ratio to decline to 83.7% in FY21, from 87.2% in FY20, as a result of rupee appreciation against the US dollar and high nominal GDP growth. This remains high relative to the 68.3% ratio of the 'B' median in 2021. Under our baseline, fiscal consolidation and solid nominal GDP growth will lead to a gradual downward trajectory in the debt ratio to about 79% of GDP by FY22. The government has continued to improve its debt management practices with extended maturities on domestic debt reducing rollover risks.
Pakistan's economy appears so far to have weathered the pandemic shock well relative to peers. Provisional data indicate GDP growth of 3.9% in FY21 (2021 B median: 4.2%), from a contraction of 0.5% in FY20 (2020 B median: -4.2%). We forecast GDP growth will stabilise at 4.0% in FY22, supported by a continued strengthening of domestic consumption and resilient manufacturing and construction activity. A recent third wave of Covid-19 cases could disrupt the positive momentum into FY22 and risks from the pandemic persist amid a sluggish vaccine rollout.
Inflationary pressures have re-emerged with the CPI reaching 11.1% yoy in April. We expect inflation to moderate to an average of 8.3% over FY22, from an average of 9.0% in FY21, as the temporary rise in food prices subsides, and the rise in oil prices moderates. As such, we expect the SBP to keep policy settings accommodative, and Fitch forecasts a policy rate hike of only 25bp, from the current 7.0%, in FY22. Risks remain that inflationary pressures could prove more persistent, particularly given a negative real policy rate, which could prompt a higher degree of tightening by the SBP.
Progress has recently been made in advancing economic reforms, although complicated by high inflation and economic pressures from the pandemic. Important measures in the pipeline include amendments to the SBP Act to improve central bank independence. Passage of reforms could prove challenging in the current political environment. The ruling PTI party gained seats in March senate elections, but fell short of a majority in the chamber.
ESG - Governance: Pakistan has an ESG Relevance Score of '5' for both Political Stability and Rights, and the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators have in our proprietary Sovereign Rating Model. Pakistan has a low World Bank Governance Indicator ranking at 21.2, reflecting a history of volatile political transitions, domestic security incidents, weak institutional capacity, uneven application of the rule of law and a high level of corruption.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade are:
- External Finances: Continued implementation of policies sufficient to facilitate a rebuilding of FX reserves and ease external financing risks.
- Public Finances: Sustained fiscal consolidation, for instance, through a structural improvement in revenue sufficient to put the debt/GDP ratio on a downward trajectory over the medium term.
- Macro: Sustained improvements in the business environment that contribute to improved medium-term growth and export prospects.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- External Finances: Indications of reduced access to external finance, leading to financing strains.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Pakistan a score equivalent to a rating of 'CCC' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
- Structural: +1 notch to adjust for the negative effect on the SRM of Pakistan's take-up of the DSSI, which prompted a reset of the "years since default or restructuring event" variable (which can pertain both to official and commercial debt). In this case, we judged that the deterioration in the model as a result of the reset does not signal a weakening of the sovereign's capacity and willingness to meet its obligations to private-sector creditors.
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 LT FC 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 and/or not fully reflected in the SRM.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
KEY ASSUMPTIONS
The world economy performs broadly in line with Fitch's latest Global Economic Outlook, published in March 2021.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Pakistan has an ESG Relevance Score of '5' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.
Pakistan has an ESG Relevance Score of '5' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Pakistan has an ESG Relevance Score of '4' for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver.
Pakistan has an ESG Relevance Score of '4' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Pakistan, as for all sovereigns.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
RATING ACTIONS
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
APPLICABLE CRITERIA
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
ENDORSEMENT STATUS
Pakistan's 'B-' rating reflects weak public finances, external finance vulnerabilities, and low governance indicator scores. The authorities have made progress in addressing external and public finance challenges over the past few years, despite the headwinds from the Covid-19 pandemic. However, economic uncertainties from the pandemic and political challenges to keeping the reform agenda on track pose risks.
A decline in external vulnerabilities has been facilitated by adherence to a market-determined exchange-rate regime, which has served as a shock absorber during the pandemic. Progress towards institutionalising this framework, if sustained, should limit medium-term risks by keeping current account deficits contained and reducing foreign-exchange (FX) reserve pressures.
External inflows have supported an appreciation of the Pakistan rupee against the US dollar and a further rebuilding of FX reserves. Fitch forecasts that official FX reserves (excluding gold) will reach USD17.4 billion (3.2 months of current external payments; 2021 B median: 4.7 months) by the end of the fiscal year to June 2021 (FY21) from USD13.3 billion at FYE20. Under our baseline, reserves are expected to rise to USD22.3 billion by FYE22, including a planned USD2.8 billion boost from the IMF's special drawing rights allocation.
We project that Pakistan's current account deficit will narrow to 0.5% of GDP in FY21, from 1.7% in FY20, due to a surge in remittance inflows, import compression, and low average oil prices. Remittance growth averaged nearly 30% yoy in FY21, reflecting a shift from informal to formal remittance channels and an underlying increase in transfers from non-resident Pakistanis. Export growth, which is key to medium-term external sustainability, has also picked up, but from low levels. We forecast a widening of the current account deficit to 1.9% of GDP in FY22 as the recovery in domestic demand and higher oil prices push imports higher.
External debt repayments will remain high, at about USD8 billion-10 billion per annum over the next few years. Participation in the G-20's Debt Service Suspension Initiative (DSSI) has reduced near-term pressures by postponing USD3.7 billion in payments previously scheduled between May 2020 and December 2021 to over a five- to six-year period.
Access to external financing from multilateral, bilateral and private sources has been sustained, facilitated by the government's policy reforms and continued progress in meeting conditions under the Extended Fund Facility (EFF) programme with the IMF. Pakistan's March 2021 Eurobond issue of USD2.5 billion had strong investor demand. China remains a key source of bilateral financing, providing about USD2.3 billion in budget support in FY21, and augmenting the size of the People's Bank of China's Currency-Swap Agreement with the State Bank of Pakistan (SBP), the central bank, by USD1.5 billion, which was used to help repay USD2 billion in deposits from Saudi Arabia in FY21.
Approval of the EFF's second-to-fifth reviews by the IMF board in March unlocked a USD500 million disbursement, marking the resumption of the programme after a pause for much of the last year due to disruptions from the pandemic. Fitch understands that negotiations for the sixth review have commenced, which are centred around the FY22 budget. We believe that completion of the review within the current June timeframe could prove challenging given divergent views over the timing and pace of tax revenue measures and energy tariff increases, as well as the appointment of a new Minister of Finance in April. However, both the government and the IMF appear committed to the programme's ultimate objectives.
Public finances remain a key weakness for the sovereign. We project the general government fiscal deficit will narrow slightly to 7.5% of GDP in FY21 (B median: 6.2% deficit), from 8.1% in FY20, as revenue growth has been resilient due to tax administration improvements and the growth rebound. We forecast a further narrowing to 6.6% of GDP on improving revenue and declining expenditure. We expect the upcoming budget to focus on enhancements to tax administration and potentially new revenue measures. The government interest burden as a share of revenue is high, at a Fitch-estimated 38.7% in FY21 (B median: 12.5%), and the narrow revenue base remains a challenge for fiscal sustainability.
We project Pakistan's debt-to-GDP ratio to decline to 83.7% in FY21, from 87.2% in FY20, as a result of rupee appreciation against the US dollar and high nominal GDP growth. This remains high relative to the 68.3% ratio of the 'B' median in 2021. Under our baseline, fiscal consolidation and solid nominal GDP growth will lead to a gradual downward trajectory in the debt ratio to about 79% of GDP by FY22. The government has continued to improve its debt management practices with extended maturities on domestic debt reducing rollover risks.
Pakistan's economy appears so far to have weathered the pandemic shock well relative to peers. Provisional data indicate GDP growth of 3.9% in FY21 (2021 B median: 4.2%), from a contraction of 0.5% in FY20 (2020 B median: -4.2%). We forecast GDP growth will stabilise at 4.0% in FY22, supported by a continued strengthening of domestic consumption and resilient manufacturing and construction activity. A recent third wave of Covid-19 cases could disrupt the positive momentum into FY22 and risks from the pandemic persist amid a sluggish vaccine rollout.
Inflationary pressures have re-emerged with the CPI reaching 11.1% yoy in April. We expect inflation to moderate to an average of 8.3% over FY22, from an average of 9.0% in FY21, as the temporary rise in food prices subsides, and the rise in oil prices moderates. As such, we expect the SBP to keep policy settings accommodative, and Fitch forecasts a policy rate hike of only 25bp, from the current 7.0%, in FY22. Risks remain that inflationary pressures could prove more persistent, particularly given a negative real policy rate, which could prompt a higher degree of tightening by the SBP.
Progress has recently been made in advancing economic reforms, although complicated by high inflation and economic pressures from the pandemic. Important measures in the pipeline include amendments to the SBP Act to improve central bank independence. Passage of reforms could prove challenging in the current political environment. The ruling PTI party gained seats in March senate elections, but fell short of a majority in the chamber.
ESG - Governance: Pakistan has an ESG Relevance Score of '5' for both Political Stability and Rights, and the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators have in our proprietary Sovereign Rating Model. Pakistan has a low World Bank Governance Indicator ranking at 21.2, reflecting a history of volatile political transitions, domestic security incidents, weak institutional capacity, uneven application of the rule of law and a high level of corruption.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade are:
- External Finances: Continued implementation of policies sufficient to facilitate a rebuilding of FX reserves and ease external financing risks.
- Public Finances: Sustained fiscal consolidation, for instance, through a structural improvement in revenue sufficient to put the debt/GDP ratio on a downward trajectory over the medium term.
- Macro: Sustained improvements in the business environment that contribute to improved medium-term growth and export prospects.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- External Finances: Indications of reduced access to external finance, leading to financing strains.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Pakistan a score equivalent to a rating of 'CCC' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
- Structural: +1 notch to adjust for the negative effect on the SRM of Pakistan's take-up of the DSSI, which prompted a reset of the "years since default or restructuring event" variable (which can pertain both to official and commercial debt). In this case, we judged that the deterioration in the model as a result of the reset does not signal a weakening of the sovereign's capacity and willingness to meet its obligations to private-sector creditors.
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 LT FC 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 and/or not fully reflected in the SRM.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
KEY ASSUMPTIONS
The world economy performs broadly in line with Fitch's latest Global Economic Outlook, published in March 2021.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Pakistan has an ESG Relevance Score of '5' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.
Pakistan has an ESG Relevance Score of '5' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Pakistan has an ESG Relevance Score of '4' for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver.
Pakistan has an ESG Relevance Score of '4' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Pakistan, as for all sovereigns.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
RATING ACTIONS
| ENTITY/DEBT | RATING | PRIOR | |||
|---|---|---|---|---|---|
| Pakistan | LT IDR | B- | Affirmed | B- | |
| ST IDR | B | Affirmed | B | ||
| LC LT IDR | B- | Affirmed | B- | ||
| LC ST IDR | B | Affirmed | B | ||
| Country Ceiling | B- | Affirmed | B- | ||
| LT | B- | Affirmed | B- | |
| The Third Pakistan International Sukuk Company Limited | |||||
| LT | B- | Affirmed | B- |
Additional information is available on www.fitchratings.com
APPLICABLE CRITERIA
- Country Ceilings Criteria (pub. 01 Jul 2020)
- Sukuk Rating Criteria (pub. 15 Feb 2021)
- Sovereign Rating Criteria (pub. 26 Apr 2021) (including rating assumption sensitivity)
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
- Country Ceiling Model, v1.7.1 (1)
- Debt Dynamics Model, v1.2.1 (1)
- Macro-Prudential Indicator Model, v1.5.0 (1)
- Sovereign Rating Model, v3.12.2 (1)
ENDORSEMENT STATUS
| Pakistan | EU Endorsed, UK Endorsed |
| The Third Pakistan International Sukuk Company Limited | EU Endorsed, UK Endorsed |
