Moody’s Investors Service on Friday said that Pakistan's debt affordability would weaken significantly from already low levels in the event of a sharp and sustained increase in the cost of debt.

Moody’s, a major credit rating agency, said that Pakistan is facing elevated external pressures stemming from strong domestic demand and capital-import heavy investments related to the China-Pakistan Economic Corridor (CPEC).

“We expect a current account deficit of 4.8% of GDP this year. While reserve coverage of external debt repayments remains adequate, we expect that coverage to weaken,” Moody’s said in its report ‘Sovereigns - Global: Contagion risks greatest where external vulnerability, weak debt affordability meet low policy credibility’.

Unless capital inflows increase substantially, possibly through and in combination with an IMF program, we see the elevated risk of a further erosion in foreign exchange reserves.

Around one-third of government debt is denominated in foreign currency. Pakistan's gross borrowing requirements are among the highest among rated sovereigns at around 27-30% of GDP.

This is driven by persistent fiscal deficits and the government's reliance on short-term debt, with an average maturity of 3.8 years.

Although Pakistan is not a major recipient of volatile capital inflows, local currency depreciation could raise inflation and prompt additional domestic rate hikes, which would pass through to borrowing costs and further weaken the government's fragile fiscal position.