ISLAMABAD: Pakistan has continued to make headway restoring economic stability and rebuilding external buffers, global credit rating agency Fitch said this week, but progress on difficult structural reforms would be key to upcoming IMF program reviews and continued financing from other multilateral and bilateral lenders.

In a note released on Thursday, Fitch said the State Bank of Pakistan’s decision to cut policy rates to 12% on Jan. 27 underscored recent progress in taming consumer price inflation, which fell to just over 2% year-on-year in January 2025, down from an average of nearly 24% in the fiscal year ended June 2024 (FY24). Rapid disinflation reflected fading base effects from earlier subsidy reforms and exchange rate stability, underpinned by a tight monetary policy stance, which in turn had subdued domestic demand and external financing needs.

“Economic activity, having absorbed tighter policy settings, is now benefiting from stability and falling interest rates,” Fitch said. “We expect real value added to expand by 3.0% in FY25. Growth in credit to the private sector turned positive in real terms in October 2024 for the first time since June 2022.”

However, the rating agency said it expected new bilateral capital flows to be increasingly commercial, and conditional on reforms. 

“Discussions on the partial sale of the government’s stake in a copper mine to a Saudi investor exemplify such commercial flows. Pakistan and Saudi Arabia also recently agreed on a deferred oil payment facility,” it added. 

Securing sufficient external financing remains a challenge for Pakistan, considering large maturities and lenders’ existing exposures. 

The authorities budgeted for about $6 billion of funding from multilaterals, including the IMF, in FY25, but about $4 billion of this will effectively refinance existing debt. A recently announced $20 billion 10-year framework with the World Bank Group appears broadly in line with this. The group’s current project portfolio is about $17 billion, and its net new yearly lending to Pakistan averaged around $1 billion over the past five years.

Strong remittance inflows, robust agricultural exports and tight policy settings have allowed Pakistan’s current account to move into a surplus of about $1.2 billion (over 0.5% of GDP) in the six months to December 2024, from a similarly sized deficit in FY24, Fitch noted. Foreign exchange market reforms in 2023 also facilitated the shift. 

“When upgrading Pakistan’s rating to ‘CCC+’ in July 2024, we expected a slight widening of the current-account deficit in FY25,” the agency added. 

Foreign reserves are set to outperform targets under Pakistan’s $7 billion IMF Extended Fund Facility (EFF) and Fitch’s earlier forecasts. Gross official reserves reached over $18.3 billion by end-2024, about three months of current external payments, up from around $15.5 billion in June.

Reserves remain low relative to funding needs, however. 

“Over $22 billion of public external debt matures in the whole of FY25. This includes nearly $13 billion in bilateral deposits, which we believe bilateral partners will roll over, as per their promises to the IMF. Saudi Arabia rolled over $3 billion in December, and the UAE $2 billion in January,” Fitch added. 

There has also been progress on fiscal reform, despite some setbacks. The primary fiscal surplus has outperformed IMF targets, although federal tax revenue grew less than required under the IMF’s indicative performance criterion in the first six months of FY25. All provinces have recently legislated higher agricultural income taxes, a key structural condition of the EFF, although delays mean that the program’s January 2025 implementation deadline for the reform was missed.

In July, Fitch noted that positive rating action could be driven by a sustained recovery in reserves and further significant easing of external financing risks, and/or implementation of fiscal consolidation in line with IMF commitments.

Meanwhile, deteriorating external liquidity, for example linked to delays in IMF reviews, could lead to negative action, the rating agency said.