Fitch downgrades Pakistan's Issuer Default Rating | What happens if the country defaults on its debt

Fitch Ratings has downgraded Pakistan's Long-Term Foreign-Currency Issuer Default Rating (IDR) by two notches to 'CCC-' from 'CCC+'. The global ratings agency cited policy and large refinancing risks, challenging political context critically low reserves and difficult conditions set by the International Monetary Fund (IMF) as the reason for the downgrade. The New York-based ratings agency warned that a default is a "real possibility".

This is the second downgrade since October, when the global ratings agency cut Pakistan’s sovereign rating from B- to CCC+, Business Today reported.

The downgrade reflected a sharp deterioration in external liquidity and funding conditions, along with decline of foreign exchange (FX) reserves to “critically low levels," Fitch was quoted by Reuters as saying.

Pakistan is experiencing one of its greatest economic crises in history as a result of rising unemployment, inflation, and poverty, endangering the rights of millions of people to food, health care, and a decent wage.

Prime Minister Shahbaz Sharif had warned of a "tough time" due to the government's inability to meet the requirements established by the IMF for the next installment of the nation's bailout package.

Just days after IMF representatives and Pakistan's Finance Minister Ishaq Dar resumed talks on the country's bailout in the capital, Islamabad, the country's foreign reserves continued to decline and are now at the dangerously low level of $3 billion.

The conditions of an IMF loan for $6.6 billion distributed over 36 months were agreed upon in 2013 by then-Prime Minister Nawaz Sharif. However, his administration was unable to increase the revenue base or privatise state-owned businesses that were losing money.

Imran Khan, the previous prime minister, launched the current bailout package in 2019, the year before he was ousted from office by a vote of parliament. Over the past two years, that loan programme has also deviated from its original route at least three times, with each new finance minister seeking to renegotiate.

Ishaq Dar was chosen as Pakistan's newest finance minister in September. He had anticipated that an IMF team would come in October to restart talks, but it wasn't until late January that it happened, a protracted wait that Dar deemed "abnormal."

The bailout has been in limbo for months due to stalling negotiations with the IMF.

The lender has reportedly put out a number of requirements for restarting the bailout, including a rise in the electricity tariff, restoration of unrestricted imports, and an increase in petroleum development levy on diesel.

The IMF bailout requirements, according to Pakistani Prime Minister Shehbaz Sharif, are "beyond our wildest dreams."

The IMF gave the finance minister a “very tough time” in the talks, Sharif had said. “Our economic challenges at the moment are unimaginable," he added. “The IMF conditions which we have to fulfill … are beyond the imagination. … But we we don’t have any other option."

The Associated Press reports that according to analysts, there is hardly enough reserves to cover the import cost for the upcoming three weeks. As a part of its $6 billion bailout plan, Pakistan is requesting a vital installment from the fund of $1.1 billion now to avoid defaulting.

In order to clear the IMF's 9th assessment of Pakistan's Extended Fund Facility and allow for the release of a $1.1 billion tranche, discussions between the two parties will continue through February 9.

According to a statement by IMF Resident Representative Esther Perez Ruiz, it is officially concentrating on programmes to restore internal and external sustainability, especially to enhance the fiscal position.

The influx would alleviate the dire need for foreign currency and open doors to other sources of assistance, such as those from multilateral and bilateral donors.

Along with the unprecedented economic crisis, Pakistan is also experiencing hurdles from the devastating floods that occurred last summer and may have cost the country $40 billion in damages. As a result, the government is finding it challenging to adhere to some of the IMF's conditions, such as raising the price of gas and electricity and enacting new taxes.

If Pakistan were to default on its debt, the country would be unable to repay commercial loans, according to a report in the Pakistani daily, the Dawn.

The central bank would have turned down debt repayment or service payments to commercial lenders if Pakistan's reserves had dropped to the extent where it would have defaulted on its commercial debt, the report explains.

This would trigger a downgrading of the country's credit rating by agencies such as Moody's and S&P, reducing international lending confidence and the government's ability to secure additional commercial debt.

The decrease in dollar inflows would limit the country's ability to import more than its exports and remittances from abroad, impacting economic output and leading to inflation. The research, prepared by Islamabad-based economist Asad Aijaz, compares this to being forced by circumstances to maintain a current account deficit close to zero.

Since the local currency of the populace also couldn't have been redeemable for consumables, inflation would have skyrocketed. If the economy had shrunk as a result of industrial losses, many people would have been laid off in a matter of weeks, leaving some individuals with nothing to spend their money on and others with no money at all.

According to the research, avoiding default even by a little margin is very different from actually defaulting because operations may continue as usual as soon as a multilateral organisation like the IMF comes with some cash in hand. In the second case, however, it will take years to rebuild the economic structure even with assistance from the international balance of payments.