Singapore, July 13, 2012 -- Moody's Investors Service has today downgraded Pakistan's foreign-
and local-currency bond ratings by one notch to Caa1 from B3.
The short-term ratings remain unchanged at Not-Prime.
The outlook is negative.
The key drivers for today's rating action are:
1.) A deterioration in Pakistan's balance of payments over
the past year
2.) The looming large repayments to the International Monetary
Fund (IMF)
3.) The dwindling level of official foreign-exchange reserves
4.) The institutional weakness stemming from political instability
and constrained government finances
RATINGS RATIONALE
The main driver of Moody's one-notch downgrade of Pakistan's
government bond ratings is the increasing strain on the country's
external payments position as a result of a rising trade deficit and decline
in capital inflows. Moreover, weak government finances,
structural inflationary pressures and domestic political uncertainties
are adding to Pakistan's external vulnerabilities and debt sustainability,
thereby compounding the downward pressure on sovereign creditworthiness.
While Pakistan recorded a small current account surplus in fiscal year
2010-11, the country's current account reverted to
a deficit of US$3.8 billion during the period from July
2011 to May 2012. The reason for the reversal in the current account
balance lies primarily in the stalled export growth recorded in the eleven
months — in contrast to a significant 28.9% expansion
in fiscal year 2010-11— due to the collapse in demand from
Europe, Pakistan's main export market, and weakening
cotton prices. In addition to the deteriorating current account
deficit, Moody's also expects the country's capital
account to exert further pressure on the balance of payments. Foreign
direct investment (FDI) has been on a secular decline since the US$5.4
billion inflow in 2008. Based on recent trends, Moody's
expects that FDI will fall short of US$1 billion in 2012.
At the same time, Pakistan's import bill, a significant
portion of which consists of subsidized petroleum products, remains
sensitive to global oil price developments.
While Moody's recognizes that worker remittance inflows have provided
much support to Pakistan's balance of payments and domestic economy
(having increased 11.9% to $15.9 billion in
the July 2011-May 2012 period from the same period a year earlier),
the rating agency also notes that recent data suggests that growth in
such inflows is tapering off. Moreover, in view of the gloomy
global economic outlook, Moody's does not consider an improvement
in Pakistan's current account to be likely over the near term.
The large upcoming repayments to the International Monetary Fund (IMF)
represent the second driver underlying Moody's decision to downgrade
Pakistan's sovereign creditworthiness. Pakistan has approximately
US$7.5 billion in principal and interest falling due to
the IMF in 2012, 2013, 2014 and 2015. Pakistan has
repaid $1.2 billion of that amount as of June, but
this still leaves sizable repayments mostly in 2013 and 2014. Additional
pressure on the balance of payments stems from the government's
decision to terminate its stand-by arrangement with the IMF in
November 2011.
The third driver of the downgrade is Pakistan's dwindling level
of official foreign-exchange reserves, which have declined
steadily after reaching an historical peak of US$16.8 billion
in July 2011. This weakening in Pakistan's external payments
position, a direct upshot of the deterioration in Pakistan's
balance of payments, raises the probability of a default over the
next year or two. As of the end of June, the Central Bank
of Pakistan's gross international liquidity, including IMF
SDR holdings, had fallen to about US$12.4 billion
(foreign-exchange reserves alone were US$10.8 billion
at the end of June). The amount of repayments that are due to the
IMF in 2013 and 2014 alone are equivalent to almost half of the central
bank's current reserve holdings.
Although official foreign exchange reserves are currently more than adequate
to cover all payments falling due on both long- and short-term
external debt in the year ahead, continued deterioration in current
account, coupled with a lack of equity or portfolio investment inflows
or a bout of capital flight, would eventually undermine reserve
adequacy. In particular, the absence of an IMF financial
support program, or in the absence of augmented and predictable
financial support from foreign governments or multilateral development
banks, would most likely lead to a more rapid decline in reserves
in the year ahead. Moody's notes that the frayed relations
between Pakistan and the United States was very recently mended to some
degree, at least for now, as the United States agreed to resume
disbursement of suspended Coalition Support Funds.
Lastly, the fourth driver of Moody's rating action is the
factious relationship between Pakistan's elected political leaders,
the judiciary and the military, which undermines the government's
ability to formulate policies to address the country's pressing
domestic economic challenges, to bolster investor confidence and
to attract much needed external financial support from official creditors
and donors. In addition, the strained condition of Pakistan's
public-sector finances and weak institutional features resulted
in the recent default (in May 2012) by the government-owned Central
Power Purchasing Agency on arrears to the private independent power producers,
the payments of which were guaranteed by the government.
As part of today's rating action, Moody's has also revised
Pakistan's country ceilings as follows: the foreign-currency
country ceiling to B3 from B1, the foreign-currency deposit
ceiling to Caa2 from B3, and the local-currency bond and
deposit ceilings to B1 from Baa2 and Ba2, respectively. The
considerable change in the local-currency ceilings reflects a downward
assessment of Institutional Strength to 'Very Low' from 'Low'
in our assessment of sovereign risk.
WHAT COULD MOVE THE RATING UP/DOWN
As reflected by the negative outlook on Pakistan's Caa1 government
bond rating, Moody's considers an upgrade very unlikely over
the medium term.
A combination of factors would prompt Moody's to consider a further
downgrade. These include a substantial worsening of the domestic
political environment and significant further deterioration in the policy
framework and investor confidence. More specifically, a continued
sizable decline in official foreign-exchange reserves, from
whatever causes—such as from a deterioration in the global demand
for Pakistan's goods and labor exports or from domestic political
paralysis or policy choices—would be strongly credit-negative
as the probability of default would increase materially.
METHODOLOGY USED
The principal methodology used in this rating was Sovereign Bond Ratings
published in September 2008. Please see the Credit Policy page
on www.moodys.com for a copy of this methodology.
REGULATORY DISCLOSURES
The Global Scale Credit Ratings on this press release that are issued
by one of Moody's affiliates outside the EU are endorsed by Moody's Investors
Service Ltd., One Canada Square, Canary Wharf,
London E 14 5FA, UK, in accordance with Art.4 paragraph
3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies.
Further information on the EU endorsement status and on the Moody's office
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Thomas J Byrne
Senior Vice President - Regional Credit Officer
Sovereign Risk Group
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Bart Oosterveld
MD - Sovereign Risk
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Moody's downgrades Pakistan's government bond ratings to Caa1, outlook negative
