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Rating Action:

Moody's downgrades Pakistan's government bond ratings to Caa1, outlook negative

13 Jul 2012

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 that has issued a particular Credit Rating is available on www.moodys.com.

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

The rating has been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

Information sources used to prepare the rating are the following: parties involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Thomas J Byrne
Senior Vice President - Regional Credit Officer
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308

Bart Oosterveld
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308

Moody's downgrades Pakistan's government bond ratings to Caa1, outlook negative
No Related Data.
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