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ISLAMABAD-Fitch Ratings downgraded the long-term foreign currency issuer rating (IDR) from “CCC+” to “CCC-“.
The downgrade reflects a further sharp deterioration in external liquidity and financing conditions and a reduction in foreign exchange (FX) reserves to very low levels. While we believe the IMF’s 9th review of Pakistan’s program to be a success, the downgrade also reflects significant risks to continued program performance and funding, including in the run-up to this year’s elections. In our view, default restructuring or debt restructuring is a more realistic possibility.
The State Bank of Pakistan’s net liquid foreign exchange reserves stood at about $2.9 billion on February 3, 2023, or less than three weeks of inflows, down from a peak of more than $20 billion at the end of August 2021. albeit narrowing, the current account deficit (CAD), external debt servicing, and prior foreign exchange interventions by the central bank, especially in 4Q22, when the informal exchange rate bottomed out. Fitch expects reserves to remain low, although we forecast a moderate recovery for the remainder of 2023, due to expected imports and the removal of exchange rate restrictions.
Public external debt maturities for the rest of the fiscal year ending in June 2023 (FY23) are over US$7 billion and will remain high in FY24. Of the remaining $7 billion in FY23, $3 billion will be China’s (SAFE) deposits, which are likely to be repaid, and $1.7 billion will be loans from Chinese commercial banks, which will also be refinanced in the near future. SAFE deposits are scheduled to be disbursed in two installments: $2 billion in March and $1 billion in June.
Pakistan’s CAD stood at $3.7 billion in 2H22, up from $9 billion in 2H21. Thus, we forecast a full-year deficit of US$4.7 billion (1.5% of GDP) in FY23, after US$17 billion (4.6% of GDP) in FY22. CAD restrictions are caused by import restrictions and foreign exchange availability, as well as by fiscal tightening, interest rate hikes, and measures to limit energy consumption. Reported unpaid imports at Pakistani ports indicate that CAD may increase once financing becomes available. However, the devaluation of the exchange rate may limit the increase, as the authorities intend to finance imports through banks, without resorting to official reserves.
Remittances may also recover after being partially diverted to informal channels in 4Q22 to benefit from more favorable rates in the parallel market. Shortfalls in revenue collection, energy subsidies and policies inconsistent with market-determined exchange rates have delayed Pakistan’s 9th IMF program review scheduled for November 2022. measures and increase the regulated prices of electricity and fuel. Conditions for the IMF are likely to be socially and politically difficult amid the severe economic downturn, high inflation and the devastation caused by last year’s widespread flooding. Elections are due by October 2023, and former prime minister Imran Khan, whose party will challenge the current government, has previously rejected Prime Minister Shehbaz Sharif’s invitation for talks on national issues, including IMF talks.
Financing conditions in the IMF program: The recent financing situation has been marked by the apparent reluctance of traditional allies – China, Saudi Arabia and the United Arab Emirates – to provide new assistance in the absence of an IMF program, which is important for other multilaterals. bilateral financing. The long-term foreign exchange IDR also reflects the following factors: New commitments by the authorities: The authorities are close to agreeing on the 9th review of the program after the end of the IMF staff visit to Pakistan on February 9 and have already taken steps to to facilitate the agreement. This includes publicly removing the rupee exchange rate ceiling in January. The prime minister has repeatedly expressed his intention to stay in this program.
Funding in the Pipeline: In addition to remaining IMF disbursements of $2.5 billion, Pakistan will receive $3.5 billion from other multilaterals once an agreement is reached with the IMF in 2023. Reports of more than $5 billion in additional commitments by allies are being considered on top of existing transfers, although details on the amount and terms are still pending. Pakistan received a pledge of $10 billion, mostly in the form of loans, at a flood relief conference in January 2023. Government committed to debt servicing: The Prime Minister also stated that it will remain current on all debt obligations. Pakistan has a sukuk due in December 2022 and the next bond payment is not due until April 2024. Restructuring cannot be completely ruled out: The previous finance minister had said before his resignation that Pakistan would seek debt relief from non-commercial creditors.
In addition, the prime minister has applied for bilateral debt relief under the Paris Club, although no formal request has been made and according to officials, this is no longer under consideration. In the event that Paris Club debt review is sought, Paris Club creditors would likely demand comparable treatment for private external creditors in any restructuring. We believe that local debt can be included in any restructuring, regardless of macro-financial sustainability considerations, as it accounts for 90% of the government’s interest burden.