Pakistan’s Progress on Structural Reform Remains Key to Credit Profile: Fitch Ratings

Pakistan has continued to make headway in restoring economic stability and rebuilding external buffers, according to Fitch Ratings. Progress on difficult structural reforms will be key to upcoming IMF program reviews and continued financing from other multilateral and bilateral lenders. The State Bank of Pakistan’s decision to cut policy rates to 12 percent on 27 January underscored recent progress in taming consumer price inflation, which fell to just over 2 percent yoy in January 2025, down from an average of nearly 24 percent in the fiscal year ended June 2024 (FY24). Rapid disinflation reflects fading base effects from earlier subsidy reforms and exchange rate stability, underpinned by a tight monetary policy stance, which in turn has subdued domestic demand and external financing needs. Having absorbed tighter policy settings, economic activity is now benefitting from stability and falling interest rates. The agency expects real value added to expand by 3.0 percent in FY25. Growth in credit to the private sector turned positive in real terms in October 2024 for the first time since June 2022. Strong remittance inflows, robust agricultural exports, and tight policy settings have allowed Pakistan’s current account to move into a surplus of about USD 1.2 billion (over 0.5 percent of GDP) in the six months to December 2024, from a similarly sized deficit in FY24. Foreign exchange market reforms in 2023 also facilitated the shift. When upgrading Pakistan’s rating to ‘CCC+’ in July 2024, the agency expected a slight widening of the current account deficit in FY25. Foreign reserves are set to outperform targets under Pakistan’s USD 7 billion IMF Extended Fund Facility (EFF) and Fitch’s earlier forecasts. Gross official reserves reached over USD 18.3 billion by end-2024, about three months of current external payments, up from around USD 15.5 billion in June. Reserves remain low relative to funding needs. Over USD 22 billion of public external debt matures in the whole of FY25. This includes nearly USD 13 billion in bilateral deposits, which the agency said bilateral partners will roll over, as per their promises to the IMF. Saudi Arabia rolled over USD 3 billion in December and the UAE USD 2 billion in January. Fitch Ratings expects new bilateral capital flows to be increasingly commercial, and conditional on reforms. Discussions on the partial sale of the government’s stake in a copper mine to a Saudi investor exemplify such commercial flows. Pakistan and Saudi Arabia also recently agreed on a deferred oil payment facility. Securing sufficient external financing remains a challenge, considering large maturities and lenders’ existing exposures. The authorities budgeted for about USD 6 billion of funding from multilateral, including the IMF, in FY25, but about USD 4 billion of this will effectively refinance existing debt. A recently announced USD 20 billion 10-year framework with the World Bank Group appears broadly in line with this. The group’s current project portfolio is about USD 17 billion, and its net new yearly lending to Pakistan averaged around USD 1 billion over the past five years. There has been progress on fiscal reform, despite some setbacks. The primary fiscal surplus has outperformed IMF targets, although federal tax revenue grew less than required under the IMF’s indicative performance criterion in the first six months of FY25. All provinces have recently legislated higher agricultural income taxes, a key structural condition of the EFF, although delays mean that the program’s January 2025 implementation deadline for the reform was missed. In July, Fitch Ratings noted that positive rating action could be driven by a sustained recovery in reserves and further significant easing of external financing risks, and/or implementation of fiscal consolidation in line with IMF commitments. Meanwhile, deteriorating external liquidity, for example, linked to delays in IMF reviews, could lead to negative action.