Moody's Investors Service on Monday changed the outlook of Pakistan from negative to stable due to stability in economic indicators.
In a statement, the ratings agency affirmed Pakistan's local and foreign currency long-term issuer and senior unsecured debt ratings at B3, and said the change in outlook to stable is driven by its expectations that the balance of payments dynamics will continue to improve, supported by policy adjustments and currency flexibility that will reduce external vulnerability risks.
Moody's also expects Pakistan's gross domestic product growth will slow to 2.9 percent in fiscal year 2019-20 from 3.3 percent in the last fiscal year, given tight financial conditions that continue to weigh on domestic demand, before rising to 3.5 percent in the fiscal year 2020-21. It further warned that foreign exchange reserve buffers would remain low and will take time to rebuild.
Moreover, while fiscal strength has weakened with higher debt levels largely as a result of currency depreciation, ongoing fiscal reforms, including through the country's International Monetary Fund (IMF) program, will mitigate risks related to debt sustainability and government liquidity.
Samiullah Tariq, director of research at Arif Habib Limited, said the credit to positive economic indicators goes to the present government's corrective measures to stabilize the economy.
"The stable outlook is primarily due to improving external finances. However the level of reserves is still not adequate to support the rupee and three-month imports," he said, adding that further improvement in economic indicators might lead to a further improvement in the country's rating.
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.
Moody's expects Pakistan's current account deficit to continue narrowing in the current and next fiscal year 2020-21, averaging around 2.2 percent of GDP, from more than six percent in fiscal year 2017-18 and around 5 percent in fiscal year 2018-19.
Under Moody's baseline assumptions, subdued import growth will likely remain the main driver of narrowing current account deficits. 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.
Moody's expects Pakistan's 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 rating agency said Pakistan's central bank 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.
The IMF program, 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.
Moody's also expects the government's fiscal deficit to remain relatively wide at around 8.6 percent of GDP in fiscal year 2020, compared to 8.9 percent in fiscal year 2019, before narrowing to an average of around seven percent over fiscal years 2021-23. High-interest payments owing to policy rate hikes will continue to weigh on government finances and significantly constrain fiscal flexibility.
Meanwhile, government revenue as a share of GDP, while likely to increase, is growing from a lower base, having declined significantly in fiscal 2019.
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