S&P downgrades Pakistan further into junk territory

HONG KONG (Reuters) - Standard & Poor's cut Pakistan's sovereign rating further into junk territory, saying the country's worsening external liquidity may imperil its ability to meet about $3 billion in upcoming debt obligations.

The widely expected action comes after Pakistan said on Saturday its foreign reserves fell $690 million to $8.1 billion in the week ended Sept. 27, an announcement that helped send the Pakistani rupee to a record low against the dollar on Monday.

The country's central bank, the State Bank of Pakistan, said its reserves fell to $4.7 billion from $5.4 billion previously, representing a little over two months of import cover.

S&P's downgrade of Pakistan was its second this year, as the country faces the prospect it will default on its debt due to dwindling foreign currency reserves.

Foreign investor confidence in the country has also been dented amid worries urgently-needed economic reforms will be delayed in a year plagued by political and security concerns.

S&P's action on Monday S&P lowered its foreign currency debt rating on the country to CCC-plus from B, just several notches above a level that would indicate default. Pakistan's local currency debt rating was lowered to B-minus from BB-minus.

The ratings agency noted Pakistan will require external assistance in meeting its debt obligations -- which includes $500 million in dollar bonds maturing in February -- but expressed concern about whether it could count on the help in time.

S&P also noted the uncertain political situation and social tension cast doubt about whether the government would have the ability to adopt the appropriate policy measures.

"The rating on Pakistan could be lowered further if the foreign exchange reserve cushion continues to shrink and meaningful economic stabilization measures remain wanting," S&P warned in its statement.

Rival credit agency Moody's Investors Service last month cut its outlook on Pakistan's debt to negative from stable, citing similar reasons, though it maintained its ratings at B2.

The cost of protection against a default in Pakistan's sovereign debt trades at 1,800 basis points, according to its five year credit default swap , a level that indicates investors believe the country is already in or will soon be in default.

An investor would thus need to pay $1.8 million annually to insure against $10 million of Pakistan's sovereign debt.

TOUGH OUTLOOK

Pakistan is in fast need of cash. According to S&P's estimates, the country's $4.7 billion in net foreign reserves at the central bank marked a 67 percent plunge from a year ago.

Its current account deficit is also running well ahead of target, reaching $2.5 billion in July and August.

That means that in just the first two months of the new fiscal 2009 year, Pakistan's shortfall reached 1.6 percent of gross domestic product, or more than a quarter of the government's full-year target of 6 percent of GDP.

Though the Asian Development Bank said last week it approved a $500 million loan to help Pakistan, the country will need far more money than that according to analysts.

A senior adviser to the government said last month the country would need $7 billion in total to cover its projected current account deficit of $14 billion for the fiscal year, of which it needed $3 to $4 billion upfront.

According to a Citigroup report last week, Pakistan is losing about $1 billion of its foreign exchange reserves a month, at a time when the prospects of raising money whether through asset sales or international bonds have become very difficult in the midst of a global financial crisis.

"At this juncture, Pakistan does not appear to have the financial sources to service its near-term amortizations, including the $500 million maturing Eurobond in February," the analysts said in the report.

Those maturing bonds were trading at 44 cents to the dollar before S&P's sovereign downgrade.

Pakistan is also facing political turmoil which includes domestic security concerns and a growing militant threat in border regions with Afghanistan.

The country's financial markets have taken a beating as a result of the uncertainty, with the benchmark Karachi Stock Index down 35 percent for the year as of last week.