Global rating agency Fitch on Monday upgraded Pakistan’s long-term foreign currency issuer default rating (IDR) to ‘CCC’ from ‘CCC-’, citing improved external liquidity and funding conditions following the staff-level agreement with the International Monetary Fund (IMF).

“We expect the SLA to be approved by the IMF board in July, catalysing other funding and anchoring policies around parliamentary elections due by October,” says Fitch in its statement. “Nevertheless, programme implementation and external funding risks remain due to a volatile political climate and large external financing requirement.”

Pakistan secured a much-needed $3 billion short-term financial package from the IMF earlier this month under the nine-month Stand-by Arrangement (SBA), which is subject to executive board approval this month.

Read: Why has the IMF been so strict on Pakistan this time?

The funding was higher than expected as Islamabad was awaiting the release of the remaining $2.5 billion from a $6.5 billion bailout package agreed in 2019.

The rating agency noted that Pakistan took measures to address shortfalls in government revenue collection, energy subsidies and policies inconsistent with a market-determined exchange rate, including import financing restrictions. These issues held up the last three reviews of Pakistan’s previous IMF programme, before its expiry in June.

Days before the expiry of programme on June 30, the government amended its proposed budget for the fiscal year ending June 2024 to introduce new revenue measures and cut spending, following additional tax measures and subsidy reforms in February.

“Another positive news towards current economic revival journey, AlhamdoLilah,” Finance Minister Ishaq Dar tweeted on Monday. He congratulated the prime minister, national, coalition partners, and his economic team on the rating action commentary.

‘Extensive record of going off-track’

Fitch also mentioned the implementation risks, citing that Pakistan has an extensive record of “going off-track” on its commitments to the IMF.

“We understand the government has already made all the required policy actions under the SBA. Nevertheless, there is still scope for delays and challenges to implementation as well as new policy missteps ahead of the October elections and uncertainty over the post-election commitment to the programme,” it added.

The board approval would unlock an “immediate disbursement” of $1.2 billion, with the remaining $1.8 billion scheduled after reviews in November and February 2024.

Saudi Arabia and the United Arab Emirates have committed another $3 billion in deposits, and the authorities expect $3 to $5 billion in other new multilateral funding after the IMF agreement. “The SBA should also facilitate disbursement of some of the $10 billion in aid pledges made at the January 2023 flood relief conference, mostly in the form of project loans [$2 billion in the budget],” said the statement.

Read: IMF Executive Board meeting on Pakistan scheduled for July 12

Commitments from the friendly countries were an important demand set by the lender for the completion of the agreement. The demand was reiterated after the disbursement was delayed by the countries, except China.

Pakistan ‘expects $25b’ in gross financing in FY24

According to the rating agency, Pakistani authorities expect $25 billion in gross new external financing in the financial year 2024, against $15 billion in public debt maturities – including $1 billion in bonds and $3.6 billion to multilateral creditors.

The government funding target includes $1.5 billion in market issuance and $4.5 billion in commercial bank borrowing, both of which could “prove challenging, although some of the loans not rolled over in the fiscal year 2023 could now return”. Nine billion dollars in maturing deposits from China, Saudi Arabia and the UAE would likely be rolled over, as in FY23.

Read: Moody’s says IMF deal will bring ‘stability’ to Pakistan

Current account deficit ‘narrowed sharply’

Fitch went on to add that Pakistan’s current account deficit (CAD) has narrowed sharply, driven by earlier restrictions on imports and foreign exchange availability, tighter fiscal and economic policies, measures to limit energy consumption and lower commodity prices.

Pakistan posted current account surpluses in March-May 2023. “We forecast a CAD of about $4 billion (1% of GDP) in FY24, after $3 billion in FY23 and over $17 billion in FY22. Our forecast CAD is lower than the $6 billion in the budget, on the assumption that not all of the planned new funding will materialise, constraining imports.”

Currency depreciation could limit rise of CAD

The agency warned of widening CAD than they expect, given continued reports of import backlogs, the dependence of the manufacturing sector on foreign inputs, and reconstruction needs after last year’s floods.

But it was of the view that currency depreciation could limit the rise, as the authorities intend for imports to be financed through banks, without recourse to official reserves. “Remittance inflows could also recover after partly switching to unofficial channels to benefit from more favourable parallel market exchange rates.”

The ‘CCC’ long-term foreign-currency IDR also reflected the following factors:

• The low foreign exchange reserves held by the State Bank of Pakistan hovered around $4 billion since February 2023, or less than a month of imports, down from a peak of more than $20 billion at end-August 2021.

• The agency highlighted the “volatile politics” of Pakistan that intensified in May after the PTI chairman’s arrest and release. Events followed protests and attacks on military installations. They culminated in a crackdown against political workers.

“Nevertheless, the enduring popularity of Mr Khan and PTI create policy uncertainty around elections.”

“We expect the consolidated general government (GG) fiscal deficit to widen to 7.6% of GDP in FY24, from an estimated 7.0% in FY23, driven by higher interest costs on domestic debt, which accounts for the difference between our forecast and a GG deficit of 7.1% of GDP in the revised FY24 budget statement (with a lower figure of 6.5% in the medium-term fiscal framework). Fiscal consolidation will drive a slight improvement in our forecast GG primary deficit to 0.1% of GDP in FY24, from 0.5% of GDP in FY23,” it said.