Dagong Upgrades the Sovereign Credit Rating of the Islamic Republic of Pakistan
Dagong Global Credit Rating Co., Ltd.
December 27, 2017
Dagong Global Credit Rating Co., Ltd. (hereinafter referred to as “Dagong”) has decided to upgrade the sovereign credit ratings of the Islamic Republic of Pakistan (hereinafter referred to as “Pakistan”) from CCC to B-, each with a stable outlook. Construction of the China Pakistan Economic Corridor (hereinafter referred to as “CPEC”) propels the Pakistani economy to grow at a faster rate while reaping the demographic dividend and improving infrastructure help generate stronger driving forces for growth, thus, Pakistan’s wealth creation capability is significantly improved and solvency in local and foreign currency have been bolstered up from a low level.
The key reasons for upgrading the sovereign credit ratings of Pakistan are as follows:
1. Debt repayment environment is generally stable, but geopolitical risks and the problem of asset quality in the banking sector require attention. With significant governing experience, strong political power and broad public support, there exists a great possibility that the Muslim League will win the 2018 general election, thus continuity of policy in the short term. Pakistan will continue to push ahead the CPEC project, privatization reform, crack down on tax evasion, strictly control firearms and ammunition, as well as strengthen the construction of energy and power infrastructure. Yet, the country’s separatist forces and terrorist attacks may affect the policy implementation. In terms of credit environment, the non-performing loan ratio of Pakistan’s banking industry has declined under strict financial supervision, but the overall level is still above 10%, which mainly exists in non-financial sectors, namely the textile industry. The risks of asset quality needs close attention.
2. In the short term, consumption and investment will boost the economy. In the medium and long term, with benefits of the demographic dividend and improvement in infrastructure, the Pakistani economy will maintain medium-high growth. Due to the fact that consumption increases, resulting from residents’ higher income and growing middle-income earners, and the fact that investment rises with the construction of the CPEC, Pakistan’s economic growth rose by 0.6 percentage points to 5.3% in FY2016/17. The short term will see the construction of power projects, airports, roads, railways and other projects under the CPEC, which will further boost consumption and investment in the country. The economic growth of FY2017/18 and FY2018/19 is projected to rise to 5.5% and 5.9% respectively. In the medium and long term, the construction of forward projects under the CPEC will help reap the benefits of demographic dividend, and the opening of the Gwadar port will promote transportation and shipping industries. It is forecasted that the following five years will witness the Pakistani economic growth rate average 5.8%.
3. Development expenditure will expand government fiscal deficit. In the short term, rapid growth will help yield more fiscal revenues, but expanded infrastructure projects will incur increasing development expenditure, thus a higher primary fiscal deficit. The Pakistani general government’s primary fiscal deficit is expected to slightly rise to 1.8% in FY2017/18 and 2.0% and FY2018/19. Deteriorating financial indicators have caused a decrease in international aid, which will affect the country’s debt repayment sources, yet, with the gradual release of economic growth potential, government debt repayment sources in the medium term are expected to improve.
4. General government solvency has improved from a low level. Fiscal deficits have pushed up the debt burden, but the revision of the Fiscal Responsibility and Debt Limitation Act can regulate federal spending and borrowing, thus slower debt growth. It is projected that FY2017/18 and FY2018/19 will see general government’s debt burden hit 74.7% and 76.2%. Although the continuing current account deficit has placed the local currency under the pressure of devaluation, the country’s total external debt is low, and international reserves’ coverage on short-term external debt is high, which helps improve the solvency in foreign currency from a low level.
In the short term, terrorist attacks will somewhat affect Pakistan’s investment environment, but the CPEC will further release the potential of economic growth and the country’s privatization reform will enhance economic vitality. Meanwhile, a relatively low total debt and a certain scale of international reserves can guarantee the stability of solvency in local and foreign currency in the short term. In general, Dagong’s outlook for Pakistan’s local and foreign currency sovereign credit ratings over the next 1-2 years is stable.