Oct. 23 (Bloomberg) -- Pakistan's possible bailout by the International Monetary Fund may not be enough to save it from a credit-rating cut, Standard & Poor's said.

``It doesn't mean they are out of the woods,'' said Agost Benard, a Singapore-based associate director at S&P, which cut Pakistan's debt rating on Oct. 6 to CCC+, seven levels below investment grade. ``It's just the first step in the right direction, or the only direction Pakistan has to go now.''

Central bank Governor Shamshad Akhtar is flying to Dubai today to hold talks with the IMF on a bailout to prevent Pakistan from defaulting on its debt, which is perceived by investors as the riskiest in the world after Argentina. IMF Managing Director Dominique Strauss-Kahn yesterday said the package was aimed at ``strengthening economic stability.''

``Pakistan has run out of options,'' Benard said in an interview in Singapore today. ``They have realized this is the only avenue left.

The government will seek funds from lenders such as the World Bank and the Asian Development Bank and donor nations before it signs up for an IMF loan, said Shaukat Tarin, finance adviser to the Pakistan prime minister. This year's funding gap is estimated at as much as $4.5 billion, he added.

``Once we know how much we will get from the multilateral lenders and donor countries, then we can decide the amount we want from the IMF,'' Tarin said in an interview from Islamabad today. ``We are talking to the IMF so that it is ready to release loans when we go to them as a last option.''

Shrinking Reserves

The nation's foreign reserves fell $570 million in the week ended Oct. 10 and have shrunk more than 74 percent in the past year to $4.3 billion. That's increased the risk that Pakistan will be unable to pay the $3 billion in debt-servicing costs due in the coming year.

Pakistan, which came off its last IMF program in December 2004, faces the politically unpopular decision to seek a bailout from the Washington-based lender after China rebuffed its neighbor's request for cash, the New York Times reported Oct. 18.

The country's first civilian government since 1999 is facing economic turmoil after the rupee plunged to an all-time low, the balance of payments deficit widened to a record, and inflation jumped to a 30-year high. The economic crisis mounted after the Pakistan Peoples Party-led government was paralyzed for almost six months because of political wrangling.

`Policy Credibility'

``IMF loans help to stabilize things more than the actual funds that are transferred to the economy,'' Benard said in a separate interview yesterday. ``It's the policy credibility that comes with it in the eyes of international investors.''

Credit-default swaps on the country's $2.7 billion of dollar-denominated bonds outstanding have more than tripled since August to 3,082.6 basis points yesterday, according to CMA Datavision. That means it costs $3.08 million annually to protect $10 million of Pakistan debt from default for five years.

Pakistan may need as much as $10 billion from overseas donors over the next two years to avoid default, IMF Regional Director Mohsin Khan said in an Oct. 20 interview. The amount of money requested ``has yet to be determined,'' Strauss-Kahn said in yesterday's statement.

Hungary, Iceland, the Ukraine and Belarus are also seeking assistance from the IMF to help weather the global financial crisis. Belarus has applied for a $2 billion loan, Interfax reported Oct. 22, and the Ukraine said this week it may sign a loan worth as much as $15 billion.

Credit Rating

Pakistan is also expected to seek financial support from the `Friends of Pakistan' group, which is due to meet next month in the United Arab Emirates. The group, which was established last month to help Pakistan stabilize its economy, includes the U.S., U.K., China and Saudi Arabia.

S&P raised Pakistan's credit rating three times between 1999 and 2004, when the South Asian country was last under an IMF program. It has lowered the rating twice this year. The IMF last rescued Pakistan from default in 1999 with a loan of about $600 million.

Pakistan's next interest payment on its dollar-denominated bonds is due in December and the government is scheduled to repay $500 million in February on a 6.75 percent note.

Moody's Investors Service lowered its credit outlook to negative on Sept. 23, citing a risk of ``missed repayments.''

Pakistan's economy has ``deteriorated significantly'' and growth may slow to a six-year low, the IMF said in an Oct. 20 report. Growth is expected to weaken to 3.5 percent in the year to June 30 from 5.8 percent last year, the IMF said.

Pakistan needs political stability and policy predictability to attract foreign investment, said Benard, who has visited the country four times since 2003. The security situation is ``getting worse,'' he said yesterday.

Military operations in Pakistan's tribal region bordering Afghanistan have triggered retaliatory attacks by militants. More than 50 people were killed in a suicide bomb attack at Islamabad's Marriott hotel on Sept. 20.

To contact the reporter on this story: Khalid Qayum in Singapore at kqayum@bloomberg.net.

Last Updated: October 23, 2008 03:14 EDT