OREANDA-NEWS. Fitch Ratings has published Pakistan's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B' with Stable Outlooks. The agency has assigned a Short-Term Foreign-Currency IDR of 'B' and a Country Ceiling of 'B'.

KEY RATING DRIVERS

The ratings reflect the following factors:

Pakistan's 'B' ratings balance the country's underdevelopment, political instability, weak public finances and history of macroeconomic volatility against the stabilisation and progress on reforms achieved under the country's latest International Monetary Fund (IMF) programme.

Pakistan entered a three-year, USD6.2bn Extended Fund Facility (EFF) with the IMF in September 2013 after a period of loose fiscal and monetary policies threatened to destabilise the economy. Since then, foreign reserves have more than doubled to USD18.7bn from USD8.6bn, and the government's annual budget deficit has almost halved to 4.8% from 8.2%.

Low external liquidity is a key credit weakness for Pakistan, although it has improved. Foreign reserves at 3.8 months of current external payments in the fiscal year ended June 2015 (FY15) are in line with the 'B' median. The country's external imbalances are modest - the current account deficit has been below 3% of GDP since 2010 and net external debt is moderate at 14.6% of GDP at end-FY15, below the 'B' median of 18.9%. Nonetheless, experience in 2013 shows how quickly Pakistan's external finances can come under pressure; in that year, Pakistan found it difficult to finance a USD2.3bn maturity that it owed the IMF.

Pakistan's economic fundamentals more broadly remain weak on many measures, even compared with low-rated 'B' range peers. Pakistan's average growth rate in the five years to FY15 was 4.2%, below the 'B' median of 4.6%. Inflation averaged 8.6% over the same period compared with a 'B' median of 4.5%, and was more volatile. Pakistan's structural weaknesses are reflected in a low investment rate of just 15% in FY15, which constrains medium-term growth prospects. Net foreign direct investment inflows averaged just 0.7% of GDP per year over FY10-FY14.

However, inflation has moderated under the IMF programme. Core inflation averaged 5.4% in January-July 2015, down from 8.2% in the same period of 2014. Headline inflation was just 1.7% in August 2015. The State Bank of Pakistan cut its policy rate 300bp since October 2014, but at 6.5% the rate remains positive in real terms.

Pakistan's structural credit fundamentals are also weak. Pakistan is one of the poorest countries rated by Fitch. Average income in FY15 was just USD1,433, well below the 'B' median of about USD3,600. Pakistan's broader level of development is well below that of 'B' peers, ranking in the 22nd percentile of the UN's Human Development Index, below the 'B' median at the 36th. The business environment is challenging, reflected in the country ranking 128 in the World Bank's Ease of Doing Business framework.

Standards of governance are low and perceptions that corruption is prevalent are high on international measures. Politically-related and terrorist violence remain severe problems despite some recent improvement in political stability. Elections in 2013 saw an orderly transfer of power between democratically-elected governments, a landmark for the country.

Pakistan's gross general government debt to GDP ratio was 64.6% at end-FY15, which is relatively high compared with the 'B' median of 51.3%, or 'BB' median of 41.6%. The country has USD4.75bn of bonds issued in international markets, although the maturity profile is moderate until USD2bn falls due in 2019. The country has a history of default, with a distressed exchange on USD3.5bn of debt under the Paris Club in 1999. However, the budget deficit has narrowed to 4.8% of GDP by FY15 from 8.4% in FY12. The government debt ratio is expected to decline gradually in Fitch's base case.

Pakistan's fiscal revenue base is narrow, with a revenue take of 15.5% of GDP in FY15 against the 25.6% 'B' median. Pakistan's revenues have also been more volatile than rating peer medians. This is partly to do with volatility in State Bank of Pakistan (SBP) profits, which accounted for 9.5% of federal government revenue per year on average over FY10-FY15. The authorities envisage lower SBP profits in future as disinflation continues and have drawn up permanent revenue-enhancing measures worth 1% of GDP in the recently introduced FY16 budget.

Nonetheless, Pakistan has made considerable progress with structural reform under its current IMF programme. The government has made a start on privatisations, accruing about 0.5% of GDP in FY15 in receipts. The authorities have a schedule of sales planned, including a stake in Pakistan International Airlines. Sales of utilities are part of a broader programme of tackling quasi-fiscal arrears in the power sector. Utility tariffs have been raised towards economic rates, and energy subsidy reductions yielded 1.2pp of GDP in fiscal savings by FY15 compared with FY13.

The banking sector is weak but has also begun to benefit from reforms. The ratio of non-performing loans (NPLs) to total loans is high at 12.8% at end-March 2015, although the ratio of NPLs net of provisions to bank capital has fallen to 9.8% from 19.9% in March 2013. System capitalisation has risen partly because of government action to tackle under-capitalised institutions, including enforcement of a minimum absolute capital amount.

The China-Pakistan Economic Corridor initiative announced in April could significantly strengthen Pakistan's economic fundamentals. China has offered to invest around USD46bn in infrastructure and energy, which includes the connection of its western city of Kashgar with the Pakistani port of Gwadar by 2030. However, the rate of progress with the scheme and the cost of any debt financing incurred by the Pakistani sovereign remain to be seen.

RATING SENSITIVITIES
The main factors that could, individually or collectively, lead to a negative rating action are:

- Policy slippage that leads to renewed pressure on basic economic and financial stability, evident in a rise in inflation or the current account deficit
- Deterioration in the fiscal position that leads to a sharp or sustained rise in government debt ratios
- Sharp deterioration in political stability, sufficient to damage the country's economic or financial stability

The main factors that could, individually or collectively, lead to a positive rating action are:

- A strengthened business environment supported by an improved security situation and decreased political risk
- Build-up of foreign reserves
- Sustained fiscal consolidation, strengthening of the revenue base, and reduction in government debt ratios

KEY ASSUMPTIONS
The ratings incorporate an assumption that Pakistan's relations with India do not deteriorate to the point of renewed armed conflict.

The global economy is presumed to perform broadly in line with Fitch's latest Global Economic Outlook report.