ISLAMABAD: International credit ratings agency Moody’s on Wednesday upgraded Pakistan’s ratings to Caa2 from Caa3 and changed the country’s outlook to “positive” citing improving macroeconomic conditions and better government liquidity and external position. 

The ratings upgrade reflects Pakistan’s decreased default risk after a $7 billion IMF bailout staff-level agreement in July.

However, despite doubling since June 2023, Pakistan’s foreign exchange reserves remain insufficient for its external financing needs, the agency said. 

“The upgrade to Caa2 reflects Pakistan’s improving macroeconomic conditions and moderately better government liquidity and external positions, from very weak levels,” the ratings agency said. “Accordingly, Pakistan’s default risk has reduced to a level consistent with a Caa2 rating.”

The agency said Pakistan’s Caa2 rating continues to reflect the country’s “very weak debt affordability,” saying that it drives high debt sustainability risk. Moody’s said it expects interest payments to continue absorbing about half of government revenue over the next two to three years.

“The Caa2 rating also incorporates the country’s weak governance and high political uncertainty,” it said. 

Moody’s said that sustained reform implementation, which includes revenue-raising measures, can increase the government revenue base and improve Pakistan’s debt affordability. 

It said completing IMF reviews in a timely manner would also allow Pakistan to continually unlock financing from official partners, sufficient to meet its external debt obligations and support further rebuilding of its foreign exchange reserves.

Moody’s said that while it expects Pakistan to cover its financing needs with funding from official partners, there remains “uncertainty” around the government’s ability to sustain reform implementation. 

It cautioned that a weak coalition government formed after the February election this year may not be able to take revenue-raising measures without stoking social tensions. 

“Slippages in reform implementation or results could lead to delays in or withdrawal of financing support from official partners,” Moody’s warned.