July 21, 2017 / 8:11 PM / 8 months ago

Fitch Affirms Cabo Verde at 'B'; Outlook Stable

(The following statement was released by the rating agency) LONDON, July 21 (Fitch) Fitch Ratings has affirmed Cabo Verde's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B' with Stable Outlooks. The Country Ceiling has been affirmed at 'B+' and the Short-Term Foreign- and Local-Currency IDRs at 'B'. KEY RATING DRIVERS Cabo Verde's ratings balance high levels of public and external debt, significant contingent liabilities and the economy's heavy reliance on the tourism sector, against a predominantly concessional public and external debt stock and solid governance indicators relative to the 'B' median. Cabo Verde has the highest public debt/GDP amongst Fitch-rated sub-Sahara African sovereigns, forecast at 128.5% at end-2016. Debt/GDP has risen from being in line with the 'B' median at 57.2% in 2008 as the previous government embarked on a large countercyclical public infrastructure investment programme following the global financial crisis and sought to take advantage of concessionary borrowing. Weak growth during the global financial and eurozone sovereign debt crises, appreciation of the non-euro external debt stock and financing of loss-making state-owned enterprises (SOE) also contributed to the rapid rise in public debt/GDP. Fitch forecasts public debt/GDP to peak in 2017 at 131.1%, before falling gradually to 100.6% by 2026 due to the government's fiscal consolidation measures and faster nominal GDP growth. Public debt reduction will largely be dependent on Cabo Verde's growth performance and on the government's fiscal stance, but could also be accelerated if the government resolves stock-flow payments and lending to the SOEs. Fitch forecasts the 2017 general government deficit to worsen temporarily to 3.1% of GDP (2016: 2.4%) due to base effects from under-spending on public investments in 2016, before falling to 1.7% by 2019. In Fitch's view, there is some risk of fiscal slippage arising from the authorities' plan to cut public investments. The 2017 budget continues the government's fiscal consolidation strategy focused on revenue administration improvements and gradual cuts in public investments and in particular front-loading cuts to domestic-finance capital spending, aimed at crowding-in the private sector. The earmarking of roughly 20% of expenditures by the government for freezing in the event of revenue underperformance is expected to mitigate risks of fiscal slippage in current expenditure. Risks from the high debt/GDP level are mitigated by a high degree of concessionality (96% of debt is concessional, with a further 3.3% of bilateral loans considered semi-concessional) on the debt stock and low debt servicing levels. The average maturity of the debt was 22 years, while 94% of the debt is fixed rate. At end 2016, 22% of total debt was in local currency, 61% of the external debt was in euros, 20% in XDR and 7% in USD, with the CVE/EUR peg mitigating external financing risks. SOE-related contingent liabilities are high and were last estimated by the government at 26.3% of GDP at end-2015. These relate mainly to the wholly state-owned airline (TACV), housing and tourism real estate company (IFH) and utilities company (Electra). The government has successfully restructured Electra to stem the need for further state support, but continues to provide significant extra-budgetary support for TACV and IFH, estimated at 4.5% of GDP in 2016. TACV's domestic routes were sold to a foreign competitor in May 2017, but it is yet to conclude a sale for the rest of the airline. The government is also planning to privatise IFH along with other SOEs. Fitch forecasts real GDP growth of 3.7% in 2017, accelerating to 4.1% in 2018-19, but lower than the government's forecast of 5.0% for 2017 (recently lowered from 5.5%). Growth will be driven by robust tourist arrivals and a large portfolio of tourism-related FDI over the coming years. Real GDP growth slowed marginally in 1Q17 to 3.6%yoy from 3.9% yoy in 4Q16 following very strong growth in the peak 4Q16 tourist season. Tourism, the mainstay of the economy, accounted for 28% of GDP in 2016, and is experiencing tailwinds from strong euro area growth and brisk UK tourist arrivals. Cabo Verde's economy lacks natural resources and is heavily reliant on imports of food and energy, making the economy vulnerable to commodity price fluctuations. It runs a structural current account deficit despite strong remittances and tourism receipts. The current account deficit narrowed in 2016 to 3.9% of GDP (2015: 4.9%) reflecting improvements in tourism receipts and current transfers, but was offset by a higher import bill due to two airplanes and the rise in international prices. Fitch forecasts the current account deficit to widen to 5.0% in 2017 and 8.7% by 2019 as private consumption and FDI led growth increases the import bill. Strong emigrant remittances support the current account balance while strong inward-FDI limit the rise of external debt-financing due to the current account deficit. Net external debt has fallen to 46.1% of GDP in 2016 from a peak of 54.3% of GDP in 2013. External debt comprises primarily public external borrowing and stable diaspora deposits, with external financing risks mitigated by low concessional borrowing rates and long maturities. The bulk of external debt is euro-denominated and supported by the CVE/EUR peg and high reserves coverage that is forecast to rise to 7.3months of external payments in 2017. Cabo Verde's governance indicators significantly outperform the 'B' median and are more in line with the 'BBB' median, reflecting the strong and democratic institutions, and underpins strong confidence for concessionary financing and foreign investments. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Cabo Verde a score equivalent to a rating of 'B+' on the Long-Term 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: - Public Finances: -1 notch, to reflect the country's high public debt stock and the risk of the large stock of SOE contingent liabilities materialising on the sovereign's balance sheet. 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. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that risks to the rating are broadly balanced. The main factors that individually or collectively, could trigger negative rating action are: - A rise in the public debt/GDP ratio, resulting from failure to consolidate the public accounts or from the materialisation of contingent liabilities. - Declining growth prospects. - A sharp increase in the sovereign's debt service burden. The main factors that individually or collectively, could trigger positive rating action are: - A marked decline in the public debt/GDP ratio - An improvement in medium term growth potential KEY ASSUMPTIONS Fitch assumes the peg with the euro will remain. Fitch assumes that concessional financing to Cabo Verde will continue to decline in line with the country's graduation to middle income status, resulting in a decline in public investments and a gradual reduction in the budget deficits. Fitch assumes eurozone growth will be broadly in line with our forecast of 2.0% in 2017 and 1.8% in 2018. Contact: Primary Analyst Eugene Chiam Director +44 20 3530 1512 Fitch Ratings Ltd 30 North Colonnade London E14 5GN Secondary Analyst Douglas Winslow Director +44 20 3530 1721 Committee Chairperson Michele Napolitano Senior Director +44 20 3530 1882 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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