Oct 13 - 19, 2008

Pakistan economy is presently burdened by rising inflation, widening trade and fiscal deficits, dwindling foreign currency reserves, sliding currency and energy shortages. International Rating agencies, Standard & Poor's and Moody's Investors Service, have both lowered the country's sovereign rating. The most serious credit challenge for the country arises from further worsening of law and order situation and political infighting, coupled with policy drift and worsening inflation and fiscal fundamentals that could further worsen macroeconomic stability.

Cutting further Pakistan's sovereign rating for the second time this year into junk territory, the Standard & Poor's on October 06 lowered foreign currency debt rating on the country to CCC-plus from B, just several notches above a default level and also lowered its local currency debt rating to B-minus from BB-minus. S&P's has warned that the country's worsening external liquidity may imperil its ability to meet about $3 billion in upcoming debt obligations, as foreign reserves held by the country's central bank have shrunk to $4.7 billion in the week ended September 27.

Last month, Moody's also changed its outlook on Pakistan's B2 bond rating to negative from stable, which reflects a worsening in access to foreign currency, raising a heightened prospect of arrears and missed repayments. It has also lowered the outlook on its B3 foreign currency bank deposit ceiling to negative. "The likelihood of further domestic political tumult amidst a growing tide of religious extremism and high inflation could slow structural reform and fundamentally weaken much-needed capacity to generate higher savings, tax revenue and foreign exchange", according to Aninda Mitra, Moody's sovereign analyst for Pakistan.

S&P's lowered debt rating on the Pakistan after its burgeoning current account deficit, foreign payments and slow foreign inflows caused a historic decline in the country's foreign exchange reserves, which fell by $688 million to $8.1 billion during the week ended on September 27, as against the $8.8235 billion a week ended on September 20. The reserves held by central bank fell by $721.2 million to $4.6859 billion, which stood at $5.4071 billion on September 20. The rapidly depleting country's foreign currency reserves may go down to $3 billion if forward liabilities are included. The real reserves are unable to meet the import bill of one month, according to the analysts. From September 22, the foreign reserves fell by around $180 million, as government made heavy payments for oil and other imports while there were no receipts.

The country is facing a total financing gap of $7 billion to cover a projected current account deficit of $14 billion in the current fiscal year (2008-09 July-June). The country hopes to bridge the gap with a Saudi oil facility worth $2.5 billion and $1.5 billion in US aid. A $500 million loan has been approved by the Asian Development Bank on September 30 to help Pakistan address the impact of high fuel and food prices, which have pushed the inflation up to more than 25 percent. The country hopes to bridge the gap with a Saudi oil facility worth $2.5 billion and $1.5 billion in US aid.

The excessive borrowing from the central bank has also put further inflationary pressure on the economy due to excessive money circulation. Burgeoning income-expenditure gap has forced the government to resort to borrowing that increased to Rs58.24 billion during the first month (July) of fiscal year 2008-09, showing an increase of 40.95 per cent compared to borrowing of Rs41.32 billion in the corresponding month of the last fiscal. During July, government's borrowing from the central bank stood at Rs30.07 billion and from scheduled banks Rs28.17 billion, against Rs41.32 billion borrowed from the central bank in corresponding month of the last fiscal. The government is likely to miss the fiscal deficit target for the current fiscal year proposed at Rs582.3 billion, which is 4.7 per cent of GDP. During the last fiscal year, the fiscal deficit stood at Rs777 billion or 7.4 per cent of GDP.

Last May, Pakistan had ventured into the international debt capital market selling $750 million worth of 10-year bonds in a deal that was seven times oversubscribed, with total demand of $3.5 billion. Standard & Poor's based the rating on reforms, inflows of foreign investment and prudent policies adopted under former President Musharraf's tenure when the country held 'B+' sovereign credit rating. In October 2003, Moody's Investors Service had raised Pakistan's ceiling for long-term foreign currency debt and bank deposits to B2 from B3 to reflect the government's narrowing fiscal deficit, the rapid decline in government debt ratios, and the strengthening of the country's external position. Though it was still five notches below an investment grade, yet it was a key sovereign credit rating for Pakistan. Moody's had viewed that political stability would be the key for a higher rating. "The ability of the government to maintain political and economic control is inordinately dependent on the presence of the president Pervez Musharraf," it had reportedly said. S&P had however cut Pakistan's sovereign rating outlook to negative after General Musharraf proclaimed state of emergency in the country on November 3. It had already warned those could all be eroded if the country remains unstable or a weak elected government emerges after the election.

Pakistan economy is presently at war on multilateral fronts- political, economic, social and external. Economically, the country is struggling with widening current account and fiscal deficits, soaring inflation, weakening rupee and falling foreign exchange reserves. Socially, Taliban-led militancy is the gravest threat to the country's tumbling economy, which is under attack from religious extremists and militants. Politically, the country witnessed perpetual instability since February 18 polls on different issues including restoration of deposed Supreme Court judges and the frequent tussles between coalition government and former president Pervez Musharraf. Pakistan Muslim League of former prime minister Nawaz Sharif, the second major political party has isolated from the Prime Minister Yousaf Raza Gilani-led- ruling coalition government and has now emerged as the major opposition party of the government. Externally, the resignation of president Musharraf in August and his replacement by the civilian president Asif Ali Zardari last month immediately brought a change in US policy that expressed in terms of US forces air strikes and ground operations against Taliban militants into Pakistani territory.

Presently, the security and political stability are the keys for Pakistan's credit rating. It is true that Pakistan is currently facing serious challenges on internal and external fronts. The international Red Cross has reportedly declared Pakistan in a state of war. If the country emerges from a phase of turmoil, it will continue to raise money in global capital markets.