LIMASSOL - The outlook for Pakistan’s banking system remains negative, says Moody’s Investors Service. The outlook reflects (1) Moody’s expectations of continued challenging operating conditions that will weigh on banks’ business generation and asset quality; and (2) banks’ high and increasing exposures to Pakistani government securities (Caa1 negative), tying the system’s solvency to sovereign event risk. Over the outlook period, however, Moody’s also expects banks to sustain low-cost and stable deposit-funded profiles, partly mitigating these negative pressures. Moody’s expects the Pakistan economy will grow in real terms by 2.8pc in 2013-14 and 3.6pc in 2014-15, below historical trends, owing to the poor domestic security situation and infrastructure bottlenecks, such as the continuing electricity outages, which weigh on manufacturing output and investment. In this environment, Moody’s expects subdued credit growth of around 3pc-5pc in 2014 (against 10% inflation), as the banks continue to devote a substantial portion of their balance sheets to finance the government’s large fiscal deficits (5.5pc of GDP in 2013-14). Furthermore, while the recent agreement with the IMF could act as a catalyst for the country to implement structural reforms and improve its growth potential, the impact will not materialise within the outlook horizon.

Moody’s notes that the banks’ exposure to government securities remains the major source of credit risk, as it links banks’ credit profiles directly to the high credit risk of the sovereign. Banks’ exposure to government securities and loans to public-sector companies reached 644% of Tier 1 capital as of September 2013 and the rating agency expects this to rise further. In addition, despite tightened underwriting criteria, the challenging operating conditions will prompt a rise in the level of the banks’ non-performing loans (NPLs) to 15pc-16c by the end of 2014 from 14.3% as of September 2013.