AKD Securities Limited – Pakistan Economy: Credit Rating change is on the cards!

Karachi, March 25, 2015 (PPI-OT): Pakistan’s sovereign credit ratings, commencing in 1994 with a ‘B+’ from S and P and a ‘Ba3’ rating from Moody’s, have gradually treaded down to B- and Caa1, respectively, at present. Moody’s last downgraded Pakistan’s rating in Jul’12 and while raised its outlook from ‘negative’ to ‘stable’ in Jul’14, it has refrained from a ratings upgrade itself.

AKD Securities Limited now believes a formal ratings upgrade is likely – based on Moody’s own methodology AKD Securities Limited posits that factors such as rising GDP growth rate, soft inflation and improvement in external liquidity should counter fiscal shortcomings and political concerns to affect a ratings upgrade.

This is underpinned by Pakistan’s macro metrics being more reflective of ‘B’ category peers (Belarus, Bangladesh, and Mongolia) rather than Caa1-rated sovereigns (Argentina, Egypt, and Greece). A rating upgrade should (i) result in better pricing for foreign debt instruments and loans, (ii) encourage increase in FDI and FPI (iii) feed into AKD Securities Limited’s thesis for valuation rerating at the KSE-100. In this regard, AKD Securities Limited estimates a rating change will increase Pakistan’s (forward) P/E to 10.0x from 8.3x at present. (AKD Securities Limited’s detailed reported on Pakistan Credit ratings to be released shortly).

Sovereign ratings revisited: Pakistan’s sovereign credit rating has seen considerable volatility, including a default in 1998. At present, S and P assigns Pakistan a sovereign Foreign Currency (FC) rating of B- (upgraded from CCC+ in Aug’09) while Moody’s rates the nation one notch lower on its equivalent scale at Caa1 (downgraded from B3 in Jul’12).

The 2012 downgrade, which has taken Pakistan’s rating to 1998 levels, occurred due to (i) a worsening external liquidity position (hefty IMF repayments) and (ii) increasing instability in the political environment. As conditions on both fronts stabilized, Moody’s changed the country’s credit outlook from ‘negative’ to ‘stable’ last year. To assess ratings outlook, this report focuses on Moody’s rating due to (i) less subjective framework than S and P and (ii) a lower rating than its counterpart.

The case for ratings upgrade: AKD Securities Limited believes that Pakistan is headed for a sovereign rating upgrade by Moody’s – one notch higher to B3, possibly by end of 2015 – where persistent issues such as a weak fiscal position and lack of institutional strength should be compensated by improved GDP growth amidst soft inflation and continued external a/c strength. AKD Securities Limited assesses each underlying ratings metric, based on Moody’s methodology, by rating (i) Economic Strength (Moderate; M) based on steadily increasing GDP growth rate (5yr avg. forecast: 4.7%); (ii) Institutional Strength (Very Low; VL+) to reflect poor governance and security concerns neutralized by recent soft inflation (Feb’15: 3.2%YoY) and monetary easing; (iii) Fiscal Strength (Very Low: VL) to accommodate a chronically low tax base (tax-to-GDP: 9%) but with a nod to recent efforts for fiscal consolidation and (iv) Susceptibility to Event Risk (High; H) to account for a fluid but comparatively better political situation and improved external liquidity (import cover: 4.8m).

Implications: A ratings upgrade should have multiple benefits; among others, (i) it should result in better pricing for foreign debt instruments and loans, (ii) encourage increase in FDI and FPI (iii) feed into AKD Securities Limited’s thesis for valuation rerating at the KSE-100. Regarding the latter, AKD Securities Limited estimates a rating change will increase Pakistan’s (forward) P/E to 10.0x from 8.3x at present. Considering Pakistan is also in the midst of monetary easing, AKD Securities Limited sees P/E (less than) 10.0x sustaining across the medium-term.