Fitch Affirms Ethiopia at ‘B’; Outlook Negative
Fitch Ratings – Hong Kong – 30 Jun 2020: Fitch Ratings has affirmed Ethiopia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘B’ with a Negative Outlook.
KEY RATING DRIVERS
(fitchratings)–Ethiopia’s ‘B’ rating balances strong medium-term economic growth potential against low development and governance indicators and low foreign currency reserves (FX), especially relative to external financing needs. The rating also reflects international financial and liquidity support to ease financing pressures, the predominance of concessional official sector borrowing relative to commercial debt and an improving policy framework.
The Negative Outlook largely reflects the risks emanating from the COVID-19 pandemic, which will significantly hit Ethiopia’s economic growth, widen the budget deficit and add further pressure to already weak external finances. Considerable political uncertainty, including a controversial delay to the 2020 parliamentary election and ethnic and regional tensions within the country, remains a risk to Ethiopia’s credit metrics, in Fitch’s view. Greater political unrest could, for example, exert further upward pressure on inflation and act as a drag on tax collection and foreign direct investment (FDI).
Ethiopia’s external finances are a key weakness for the rating. Persistent current account deficits (CAD), low FX reserves and rising external debt repayments present a risk to external debt sustainability. We forecast that the CAD will narrow to 4.3% of GDP in the fiscal year to end-June 2020 (FY20) and widen to 4.5% of GDP in FY21 (USD4.8 billion). This follows a trend of CAD moderation from 12.5% of GDP in FY15, helped by restraint on government and SOE imports and despite declines in export receipts. However, net FDI fell from 4.1% of GDP on average in FY15-FY18 to 3.1% in FY19 and likely 1.5% in FY20. Proposed sales of mobile licenses and a stake in Ethio Telecom, the state-owned telecoms company, are an upside risk to inflows in FY21 as we have not assumed inflows from these sources in our forecasts given uncertainty over timing.
External financing requirements are high relative to FX reserves, which we expect to be around USD3 billion at the end of June, covering only around two months of current external payments. Prior to the G20’s DSSI, Ethiopia faced an external financing requirement of USD6.2 billion in FY21, including USD1.3 billion of federal government and SOE amortisation. External amortisation will be lower in light of the DSSI, which for Ethiopia could suspend USD800 million of external debt service in May-December 2020 according to the Ethiopian Ministry of Finance. It remains unclear whether the initiative will be extended into 2021.
Fitch’s sovereign ratings apply to borrowing from the private sector, so official bilateral debt relief would not constitute a default, although it can point to increasing credit stress. Ethiopia’s external debt profile incorporates a high share of concessional and official sector loans. Government and SOE government-guaranteed debt owed to private creditors totalled USD3.4 billion, or less than 4% of GDP, at end-2019. Of this total, Ethiopia has USD1billion of outstanding Eurobonds maturing in 2024, with an annual debt service cost of USD66 million, which should be manageable, in Fitch’s view. Other SOE debt to private creditors which relates to Ethio Telecom and Ethiopian Airlines is a further USD3.5 billion. While this is not guaranteed by the government and is currently performing, it represents a potential contingent liability.
Prior to the COVID-19 pandemic and the G20 DSSI initiative, financial support from bilateral and multilateral partners was already important in mitigating pressure on Ethiopia’s FX reserves. A multi-year agreement with the World Bank brought in budget support funds starting in late 2018. Ethiopia and the IMF agreed a three year programme in December 2019 (now worth USD2.7 billion); Ethiopia also received USD411 million in May 2020 via the IMF’s Rapid Financing Initiative and debt to the IMF of USD12 million was cancelled under the IMF’s Catastrophe Containment and Relief Trust.
In addition, Ethiopia and China agreed in early 2019 to reprofile some SOE debt to Chinese creditors, securing more favourable terms including extension of grace periods. Ethiopia is also finalising agreement with official creditors in the Gulf to extend the tenors of foreign deposits at the National Bank of Ethiopia (NBE, the central bank). Our numbers incorporate estimates for both of those re-profiling exercises. In aggregate, these official sector financing initiatives provide material support to Ethiopia’s credit profile, mitigating the external financing pressures indicated by the headline numbers.
The authorities had adopted somewhat tighter fiscal and monetary policies, prior to the COVID-19 pandemic, to try to combat macroeconomic and external imbalances and FX shortages. Public sector debt was moderating, as was the CAD. The budget deficit in 1HFY20 was smaller than the IMF programme target, reflecting improved tax collection. Ethiopia initiated new T-bill auctions to make domestic financing more market driven. NBE allowed faster depreciation of the overvalued exchange rate, helping to narrow the gap with the weaker parallel exchange rate, although this remains large (more than 25% in April).
Inflation remains very high despite tightening measures by the NBE, with upward pressure coming from supply side factors, notably food price inflation. We expect inflation to average 18% in FY21, following an average of 20% in FY20. We have revised down our real GDP growth forecasts to just over 3% on average across FY20 and FY21 from just over 7% previously because of the negative impact of COVID-19 on economic activity. Infrastructure investment, expanding manufacturing supply and urbanisation should underpin a growth recovery over the medium term. Political instability and balance of payments strains present downside risks.
We forecast the general government budget deficit to widen to 4.0% of GDP in FY20, as the government deploys a stimulus of 1.6% of GDP up to end-June. The lingering impact of the pandemic will keep the deficit at a similar level in FY21, before stronger growth and reduced crisis-related spending needs narrow the deficit thereafter.
We forecast that general government debt will increase modestly, to 32% of GDP, as will total public sector debt to 59% of GDP for FY20. The latter includes around 20% of GDP of non-guaranteed SOE debt, including debt of Ethiopian Airlines and Ethio Telecom. The government has maintained a policy of no new non-concessional external debt and is focusing on completing the existing portfolio of projects rather than starting new projects. We expect debt levels to decline modestly provided the economy returns to healthier growth levels in FY22.
ESG – Governance: Ethiopia has an ESG Relevance Score (RS) of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Ethiopia has a low WBGI ranking in the 24thpercentile.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Ethiopia a score equivalent to a rating of ‘B-‘ on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
External Finances: -1 notch, to reflect the high level of net external debt (including SOE external debt) and low foreign-currency reserves in the context of a structural current-account deficit and managed exchange rate.
Structural Features: +2 notches to adjust for the negative impact on the SRM of Ethiopia’s take-up of the DSSI, which prompted a reset of the ‘years since default or restructuring event’ variable (which can pertain both to official and commercial debt). In this case we judged that the deterioration in the model as a result of the reset would be overly punitive as a signal of the sovereign’s capacity and willingness to meet its obligations to private-sector creditors.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Factors that could, individually or collectively, lead to negative rating action/downgrade: – Increased external vulnerability, such as the emergence of external financing gaps, particularly in relation to private sector creditors, and further downward pressure on already low foreign-exchange reserves. – Sizable increase in government or broader public sector debt relative to GDP, reflecting higher fiscal deficits, weaker growth or crystallisation of contingent liabilities from SOEs on the sovereign’s balance sheet. – Political instability that leads to macroeconomic spillovers such as disruptions to FDI, higher inflation, lower growth or fiscal slippages. Factors that could, individually or collectively, lead to positive rating action/upgrade: – Stronger external finances with acceleration in exports leading to smaller CADs and higher foreign-currency reserves. -Trend decline in public-sector debt/GDP resulting from continued restraint on SOE borrowing and/or moderate budget deficits in the context of strong recovery in economic growth. – Significant improvement across structural factors, such as governance standards, political stability, the business environment and income per capita.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].
We expect global economic trends and commodity prices to develop as outlined in Fitch’s Global Economic Outlook.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Ethiopia has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are highly relevant to the rating and a key rating driver with a high weight.
Ethiopia has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Ethiopia has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as strong social stability and voice and accountability are reflected in the World Bank Governance Indicators that have the highest weight in the SRM. They are relevant to the rating and a rating driver.
Ethiopia has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Ethiopia, as for all sovereigns.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.
|Ethiopia||LT IDR||B –||Affirmed||B|
||LC LT IDR||B –||Affirmed||B|
||LC ST IDR||B||Affirmed||B|