ISLAMABAD: Rating agency Moody’s said on Wednesday the Pakistani government’s credit profile was stable on the back of reforms and policy effectiveness, adding that the country’s banking system reflected banks’ solid funding and liquidity, although a challenging operating environment would weigh on asset quality and profitability.
Moody’s published its outlook on the Pakistan Banking System titled, “Banking System Outlook – Pakistan: Stable outlook balances loan book and profitability pressure against stable funding and a resilient sovereign.” 
“Despite a difficult environment, the government’s credit profile is stable due to ongoing reforms and increasing policy effectiveness – a positive for the banks given their outsized holdings of Pakistani government debt link their credit profiles to that of the government,” said Constantinos Kypreos, a Moody’s Senior Vice President. “Deposit-based funding and good liquidity buffers also remain strengths, while the probability of government support in a crisis is high, even if its ability to do so is limited by fiscal challenges.”
The report said restrictions in place to contain the spread of the coronavirus would keep economic activity below pre-outbreak levels but the Pakistani economy was expected to return to modest growth of 1.5% in fiscal 2021.
“Government and central bank policy responses and structural reforms will soften the pandemic’s impact but not fully offset it,” the report said. “In this environment, we expect private-sector lending to grow modestly, by 5%-7%, over the calendar year.”
Nonperforming loans (NPLs) would rise from a sector-wide level of 9.9% of gross loans at September 2020 as the economic slowdown took a toll on borrowers’ repayment capabilities, the report said. Banks’ foreign operations, export-oriented industries and companies that depend on government payments and subsidies would be hit hardest. Loan repayment holidays and other support measures would contain the deterioration, but not eliminate the risks entirely. Banks’ heavy exposure to government bonds would also continue to link banks’ credit profiles with the fiscal strength of the government.
The report also said capital was modest but would remain broadly stable and profitability had materially increased during 2020, but would come under some pressure in 2021: Net interest margins will narrow after a huge 625-basis-point interest rate cut in 2020. Together with rising provisioning needs and subdued business generation, this will curb bottom-line profits.
“The government remains willing to support troubled banks but its ability to do so is limited by fiscal challenges reflected in its B3 rating,” the report concluded.