The Hindu Business Line : Delving into Pakistan's `negative' rating

Pakistan is at `a turning point,' recognises a recent report from Standard & Poor's Ratings Services (S&P). "A rapid succession of events over the past eight months has led to considerable uncertainty about the fate of the Musharraf administration, which has governed Pakistan since October 1999," it begins, sombrely.

"The relative certainty of an authoritarian administration strongly focused on the economy and with a generally good policy mix will likely give way to an elected government whose policy orientation, cohesion, and efficiency have yet to be revealed and tested," continues the November 27-dated report.

About a month ago, soon after Pervez Musharraf declared a state of emergency in Pakistan, S&P revised the outlook on the sovereign rating to `negative', stating that the action would `prolong and exacerbate the uncertainties, potentially putting downward pressure on the ratings if fiscal and external balances deteriorate.'

The authors of the latest report observe that the risk of prolonged stalemate and disruption remains, "especially considering Musharraf's weakened position combined with the contest between two former prime ministers and fierce rivals Benazir Bhutto and Nawaz Sharif, both of whom are trying to re-establish their once dominant political positions."

Business Line contacted the report's `primary credit analyst' Mr Agost Benard, Associate Director, Sovereign and International Public Finance Ratings, S&P, and posed a few questions.

Excerpts of the e-mail interview:

What does the shift from `stable' to `negative' signify?

A shift of the "outlook" on the ratings from "stable" to "negative" is an indication of the likely direction the ratings will take over the next 18 months.

Put differently, a negative outlook means that out of the three possible outcomes for the rating - moving up, staying where it is, or moving down - "moving down" has a higher probability of occurring than the other two outcomes.

Do you see the sovereign rating impacting the forex and local currency ratings too?

The sovereign rating pertains to both local and foreign currency debt, and the outlook is therefore applicable to both.

Can you outline the triggers that have had adverse effect on the country's economy? And, would it be possible to put a price tag on what the emergency would cost, and also, estimate how many years of development are being reversed in the process?

From a credit rating perspective, the main adverse effects, or possible "triggers" caused by continued political uncertainty, are likely to be as follows:

Damage to external liquidity if foreign investment inflows which support the balance of payments against large current account deficits were to slow down significantly.

Slowdown in economic growth rates if investor confidence, both foreign and domestic, is damaged.

Fiscal slippage, i.e., an increase in deficits, slowing down or reversing the country's debt reduction. This may happen either as a result of withering revenue effort due to weakening administration or to policy-induced profligacy, should current fiscal policies be replaced by more populist and less disciplined management under a future leadership.

As for the question of "putting a price tag" on the emergency, and working out "how many years it will set the country back", we do not make these types of calculations.

Have we had similar examples in recent times? What was the response of S&P when India endured emergency, about three decades ago?

One recent example is Thailand, where after the September 2006 military coup, the ratings were placed on "Credit Watch Negative". India did not have a sovereign rating from S&P three decades ago.

Could the downgrade have come earlier, in the case of Pakistan, considering the happenings?

Please note that the ratings did not change, hence we can't speak about a downgrade. It is only an outlook change. The previous outlook change from `positive' to `stable' occurred in July in response to political uncertainty, and the latest move reflects the increase in uncertainty.

Your comments about the pain points in the country's financials.

These comments refer to the country's fiscal deficits, running at about 4 per cent of GDP (gross domestic product).

As noted above, in my reply to an earlier question, there is some risk that this may increase under certain circumstances, and this constitutes one of the risk factors for the rating.

What is the ROI that FDI is earning in Pakistan? How does that compare to what is available in the neighbouring countries?

We do not have information on the ROI (return on investment) of FDI (foreign direct investment) in Pakistan.

What clinching evidence would you look for before revising the rating upwards?

The outlook could move back to `stable' on evidence that the political situation normalises through an orderly transition of power, and that fiscal policies remain focused on maintaining the country's downward debt trajectory.

D. MURALI

http://InterviewsInsights.blogspot.com

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Delving into Pakistan's `negative' rating