Moody’s cuts Pakistan ratings – Why now?

 

Pakistan rating at 1998 levels and worse than 2008 crisis 

Moody's has downgraded Pakistan's foreign and local currency long term bond ratings by one notch to Caa1 from B3. Short-term ratings remain unchanged at Not-Prime. The outlook is negative. This takes Pakistan's rating at par with levels seen post nuclear tests in 1998 and a notch lower than the 2008 crisis, where there was grave concern over Pakistan defaulting on its sovereign bond and CDS spreads were at 5,000bp (CDS day before latest rating cut: 860bp). Hence the cut to Caa1 has raised questions over timing among market participants. 

What has driven the ratings cut? 

As per Moody's the key drivers for the cut are: 1) Deterioration in balance of payments over the past year; 2) the looming large repayments to the IMF; 3) the dwindling level of official foreign-exchange reserves and 4) institutional weakness stemming from political instability and constrained government finances. 

Timing of the cut appears a little harsh 

We believe that the timing of the ratings cut is a little harsh, considering recent developments. IMF payments and political noise are unchanged but two major positive developments of the last few weeks, which have also instilled some stability in the currency market deserve more weight in our view: 

· There has been visible improvement in Pak-US relations with Pakistan opening supply routes for NATO and US likely to disburse pending CSF flows worth US$1.1bn. A Pak-US patch up is likely to have follow-through impact on other pending sovereign flows, as well as achieving potentially favorable terms with the IMF, in our view. In fact, there is newsflow over the weekend that Pakistan might get a waiver and qualify for a PRGF program, if required. 

· Oil prices have softened ~20% off recent peak and Pakistan's reliance on imported oil makes it a net beneficiary, easing external account pressures. 

Market reaction 

KSE elicited a muted response but the impact of the ratings cut on FPIs remains an area of interest for investors. While the impact is not likely to be proportionate, an analysis of KSE's PE vs credit rating is given inside. Pakistan bond yields and CDS are not liquid and hence the true price reflection might take a day or two to crystallize. However domestic bond market did see yields tick up marginally, as the rating cut instilled some doubts on the possibility of easing in the near term.  

Banks' rating downgrade likely to follow 

A downgrade of banks' rating is also likely to follow as Moody's recently lowered its standalone credit assessments of Pak banks to B3, in line with the country's sovereign debt rating. Moody's reasoned that standalone ratings of banks in Pakistan cannot be higher than country given their exposure to govt debt.

Moody’s cuts Pakistan ratings – Why now?