In addition, we affirmed the 'B-' issue rating on the sovereign's senior unsecured foreign-currency debt, as well as its recovery rating of '3', which denotes the expectation of a meaningful recovery of 50pc-70pc in the event of a distressed debt exchange or payment default. "The ratings affirmation takes into account Pakistan's low income level, high public and external leverage, political and security risks, and fiscal inflexibility due to an exceedingly narrow tax base," said Standard & Poor's credit analyst Agost Benard. "These constraints are balanced against an adequate external liquidity position largely due to the earlier IMF standby loan agreement and donor support."
Pakistan's high public and external indebtedness is a rating constraint. Standard & Poor's estimates Pakistan's net general government debt at 50 percent of GDP in 2011, and about 40 percent of it is external debt. Although the debt-to-GDP ratio has fallen from 74 percent a decade ago, this was mostly due to debt forgiveness and high nominal GDP growth due to double-digit inflation in the past four years, Benard said.
The country's fiscal inflexibility particularly its narrow revenue base has been a key reason behind fiscal slippages, including missing agreed targets under the IMF standby loan agreement. The inability to implement structural revenue reforms continues to undermine public finances, and has resulted in the suspension of the IMF loan agreement well ahead of its expiry in September this year.
"The weak revenue performance also poses a direct constraint on monetary policy effectiveness, as the government is compelled to resort to borrowing from the central bank for deficit financing," Benard said. Pakistan's other rating constraints are its low income level and political risk, stemming from regional insurgencies, sectarian strife, and a volatile and adversarial domestic political setting.
The country's adequate external liquidity supports the ratings on Pakistan. Buoyant remittance inflows, successive loan disbursals by the IMF, and other multilateral loans have materially reduced the risk of near-term external payment difficulties for Pakistan.
Although the current level of external liquidity is likely to diminish somewhat, given the expiry of the IMF loan program in September and the current account likely returning to a deficit position, we expect donor commitments will ensure at least adequate external liquidity in the next two years.
The stable rating outlook balances adequate external liquidity against vulnerability stemming from ongoing structural fiscal weaknesses and significant political and security risk. We could lower the ratings if major slippages in policy occur, resulting in renewed balance-of-payments difficulties or rising public debt trajectory. Conversely, we could raise the ratings if Pakistan shows progress in its fiscal consolidation efforts, manifested in moderating fiscal deficits and steady reduction in the public debt burden.