SINGAPORE – Moody's Investors Service has downgraded Friday Pakistan's foreign- and local-currency bond ratings by one notch to Caa1 from B3. The short-term ratings remain unchanged at Not-Prime. The outlook is negative. The key drivers for rating action are: 1.) A deterioration in Pakistan's balance of payments over the past year. 2.) The looming large repayments to the International Monetary Fund (IMF). 3.) The dwindling level of official foreign-exchange reserves. 4.) The institutional weakness stemming from political instability and constrained government finances. The main driver of Moody's one-notch downgrade of Pakistan's government bond ratings is the increasing strain on the country's external payments position as a result of a rising trade deficit and decline in capital inflows. Moreover, weak government finances, structural inflationary pressures and domestic political uncertainties are adding to Pakistan's external vulnerabilities and debt sustainability, thereby compounding the downward pressure on sovereign creditworthiness. While Pakistan recorded a small current account surplus in fiscal year 2010-11, the country's current account reverted to a deficit of $3.8 billion during the period from July 2011 to May 2012. The reason for the reversal in the current account balance lies primarily in the stalled export growth recorded in the 11 months - in contrast to a significant 28.9 percent expansion in fiscal year 2010-11- due to the collapse in demand from Europe, Pakistan's main export market, and weakening cotton prices. In addition to the deteriorating current account deficit, Moody's also expects the country's capital account to exert further pressure on the balance of payments. Foreign direct investment (FDI) has been on a secular decline since the $5.4 billion inflow in 2008. Based on recent trends, Moody's expects that FDI will fall short of $1 billion in 2012. – SG
