ISLAMABAD: Fitch Ratings has acknowledged Pakistan`s progress in restoring economic stability and strengthening external buffers but cautioned that structuralreforms and externalfinancing remain key challenges.

In a special note issued on Friday ahead of Pakistan`s first biannual review under the International Monetary Fund (IMF) programme, the New Yorkbased rating agency alerted that progress on difficult structural reforms would be key to the IMF programme reviews and continued financing from other multilateral and bilateral lenders.

`Pakistan has continued to make headway restoring economic stability and rebuilding external buffers,` it said.

The State Bank of Pakistan`s decision to cut policy rates to 12 per cent on Jan 27 underscored recent progress in taming consumer price inflation, which fell to just over 2pc year-on-year in January 202s, down from an aver-age of nearly 24pc in the fiscal year ended June 2024 (FY24).

`Rapid disinflation reflects fading base effects from earlier subsidy reforms and exchange rate stability, underpinned by a tight monetary policy stance, which in turn has subdued domestic demand and external financing needs,` it observed.

Economic activity, having absorbed tighter policy settings, is now benefitting from stability and falling interest rates, the rating firm noted, expecting the real value added (gross domestic product) to expand by 3pc in FY25.

Growth in credit to the private sector turned positive in real terms in October 2024 for the first time since June 2022.

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 0.5pc of GDP) in the six months to December 2024, from a similarly sized deficit in FY24.

Foreign exchange market reforms in 2023 also facilitated the shift. When upgrading Pakistan`s rating to `CCC+` in July 2024, Fitch forecasted a slight widening of the current account deficit in FY25.

Fitch said Pakistan`s foreign reserves were set to outperform targets under Pakistan`s $7bnIMF Extended Fund Facility (EFF) and Fitch`s earlier forecasts. Gross official reserves reached over $18.3bn by end2024, about three months of current external payments, up from around $15.5bn in June.

`Reserves remain low relative to funding needs,` Fitch noted, explaining that over $22bn of public external debt was maturing in the whole of FY25. This includes nearly $13bn in bilateral deposits, from friendly partners who were expected to roll over these deposits as per their promises to the IMF. Saudi Arabia rolled over $3bn in December and the UAE $2bn in January.

Fitch predicted the 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.

`Securing sufficient external financing remains a challenge, considering large maturities and lenders` existing exposures,` the rating firm said, adding that the authorities budgeted for about $6bn of funding from multilaterals, including the IMF, in FY25, but about $4bn of this will effectively refinance existing debt.

A recently announced $20bn 10-year framework with the World Bank Group appeared broadly in line with this. The World Bank`s current project portfolio is about $17bn, and its net new yearly lending to Pakistan averaged around $1bn over the past five years.

The firm noted that there had been progress on fiscal reform despite some setbacks.

All provinces have recently legislated higher agricultural incometaxes, a key structural condition of the EFF, although delays mean that the programme`s January 202s 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 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, it warned.