Amidst difficult economic conditions, Moody's Investors Service has downgraded the outlook on Pakistan's rating to negative from stable and affirmed the 'B3' local and foreign currency long-term issuer and senior unsecured debt ratings. According to the agency, the decision to change the outlook to negative is caused by Pakistan's heightened external vulnerability risk. Foreign exchange reserves have fallen to low levels and without significant capital inflows will not be replenished over the next 1218 months. Low reserve adequacy threatens continued access to external financing at moderate costs, in turn potentially raising government liquidity risks. It may be added here that a rating is Moody's opinion of the credit quality of individual obligations or of an issuer's general creditworthiness. Investors use ratings to help price the credit risk of fixed-income securities they may buy or sell.
Needless to say, the development comes as a blow to us because we are facing difficulties in taming a bulging import bill that is eating away at the country's foreign exchange reserves. From almost $ 19.46 billion held by the State Bank of Pakistan in October 2016, foreign exchange reserves dropped 48.3% to $ 10.07 billion on June 8, 2018. The decline comes at a time when the import bill peaked to a record high of $ 5.8 billion in May, increasing the already swelling trade and current account deficits. The fragile external account position has already forced the SBP to let go off the Pakistani rupee that has now weakened over 15% in the last seven months after three separate rounds of devaluation. Moody's acknowledged Pakistan's robust growth potential, but pointed out that these strengths balance the country's fragile external payments position as well as the "very weak" government debt affordability.
The decision to affirm the B3 rating reflects Pakistan's robust growth potential, supported by ongoing improvements in energy supply and physical infrastructure, which are likely to raise economic competitiveness over time.These credit strengths balance Pakistan's fragile external payments position and very weak government debt affordability owing to low revenue generation capacity.The ratings agency also expects Pakistan's external account to remain under significant pressure. The coverage by foreign exchange reserves of imports will likely fall further from already low levels, while coverage of external debt payments due will weaken from currently adequate levels.In turn, higher foreign currency borrowing needs, in combination with the low levels of foreign exchange buffers, risks weighing on the ability of the government to access external financing at moderate costs.
As experts have pointed out, continued growth in imports - driven by demand for capital goods under CPEC, higher fuel prices and robust household consumption - will prevent a significant narrowing of the current account deficit. Although exports have picked up since the start of 2018, growing around 10-15% year-on-year in US dollar terms, they only amount to half the level of goods imports.Unless capital inflows increase significantly, Moody's does not expect official foreign exchange reserves to replenish from their current low levels. Under baseline projection, the import cover of reserves will likely fall to around 1.7-1.8 months over the next fiscal year, below the adequacy level of three months generally recommended by the International Monetary Fund.
Significantly, Moody's expects the government's tax amnesty scheme, which expires in June 2018, to have a modest impact of around $2-3 billion in foreign exchange inflows.Secondly, the coverage by foreign exchange reserves of external debt payments due is weakening, pointing to further external vulnerability. With a significant rise in equity inflows unlikely, Moody's projects that Pakistan's external financing gap will be be met by increased foreign currency borrowing.The outlook would likely be changed to stable if external vulnerability risks decreased materially and durably, including through policy adjustments that strengthen the external payments position.