December 21, 2017 / 11:35 AM / a year ago

Fitch Affirms Ethiopia at 'B'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, December 21 (Fitch) Fitch Ratings has affirmed Ethiopia's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B' with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS Ethiopia's 'B' rating is constrained by low development and governance indicators that rank among the weakest in the universe of sovereigns rated by Fitch. The rating also balances strong economic growth supported by the country's ambitious industrialisation strategy against the attendant macroeconomic imbalances illustrated by a wide, but narrowing, current account deficit, thin external buffers and investment-related build-up of public sector debt. The current account deficit (CAD) has narrowed to 7.9% of GDP in fiscal year 2017 (FY17, year to 7 July 2017) from 11.5% of GDP in FY16 due to a slowdown in import-intensive public investment. Major infrastructure projects have been completed and the government is taking steps to curb debt accumulation by state-owned enterprises (SOE). Export performance remained subdued due to low agricultural commodity prices, birr overvaluation, delays in some infrastructure projects and persistent structural impediments, including high logistic costs and lack of skilled labour. We forecast exports to gather pace and the CAD to narrow further to 6.6% of GDP in FY19. Manufacturing exports will strengthen as industrial parks, including the flagship Hawassa, ramp up production. The coming online of new generation capacities is bolstering exports of electricity. The Addis Ababa-Djibouti railway has reportedly started operating and will reduce transport costs for the landlocked country's exporters. Moreover, net FDI has risen to USD4.2 billion in FY17 from USD2.6 billion in FY15, funding a larger share of the smaller CAD. This allowed the public sector to reduce its net external borrowing to USD2 billion in FY17 from USD5 billion in FY15, lowering its financing requirement and concerns about external debt sustainability. The National Bank of Ethiopia (NBE) devalued the birr by 13% against the dollar in October. The IMF estimates that the birr was overvalued by 20%-40%, impeding export performance. Despite the recent adjustment, the informal exchange rate is still 12% lower than the official rate according to the NBE, pointing to some persistent overvaluation. Downward pressures on the birr are mitigated by the closure of the financial account, but the shortage of foreign currency is a major constraint on private sector activity. The devaluation of the exchange rate should contribute to the rebalancing of the economy towards the tradable sector, conditional on a limited pass-through to domestic inflation leading to a depreciation of the real effective exchange rate. The NBE has tightened its policy stance in conjunction with the devaluation to forestall inflation pressures. The central bank raised the minimum rate on deposits to 7% from 5% and cut the ceiling on the growth rate of loans to the non-tradable sector to 16% from 22% previously. The government has also taken administrative measures to limit the increase in prices. However, headline inflation accelerated to 13.6% in November, its highest level in five years, from 10.8% in September. We forecast inflation to accelerate to 15% and slowly moderate thereafter, but still breach the NBE's target of 9%, as the tightening of monetary policy is gradually transmitted to the economy. Political tensions have increased over the last two years and Ethiopia's system of ethnic federalism is facing challenges. The clampdown on anti-government protests in 2016-17 and recent ethnic strife in the south have strained the relationship between the four constituents of the ruling Ethiopian People's Revolutionary Democratic Front (EPRDF). The Congress of the EPRDF was delayed to March 2018 and will be a major event that could lead to changes in the distribution of power within the coalition, in Fitch's view. Further deterioration in political stability is a risk. The state of emergency imposed in October 2016 was lifted in August. However, tensions remain high as illustrated by protests against tax measures in Oromia in July and repeated ethnic clashes between Oromos and Somalis. Heightened political and social tensions underscore the challenges raised by Ethiopia's weak structural features. Human and economic indicators rank among the lowest of Fitch-rated sovereigns. Ethiopia's GNI per capita at PPP represents only 21% of the 'B' category median. The general government (GG) deficit widened to 3.3% of GDP in FY17 from 2.4% in FY16. We expect it to average 3.2% of GDP in FY19-FY20 up from 2.3% in FY14-FY16. Revenues/GDP has weakened due to challenges in tax collection causing tax receipts to underperform against targets over the last five quarters. Income tax brackets have also been adjusted for inflation and grant disbursements have dropped. Lower capital spending is partly offset by the rise in current spending due to higher drought-related relief expenditures and the increase in public sector wages. The government has reduced its recourse to external funding to preserve debt sustainability, resulting in a decline in aggregate public sector external debt, including SOEs, to 29.3% of GDP in FY17 from 30.7% in FY16. The authorities are increasingly tapping domestic funding sources, mainly public banks and the NBE. We expect domestic financing to cover two-thirds of the budget borrowing needs in FY18 and FY19, up from less than 50% over the previous five years. External refinancing risks are mitigated by the high share of concessional loans in public external debt, at 51% in FY17. The authorities are also striving to mobilise non-debt financing. They have stepped up the privatisation process and are envisaging the sale of some public manufacturing companies. They are also developing the legal framework for public-private partnerships to fund investments in the energy and transport sectors. We expect the public sector's aggregate debt, including SOEs, to stabilise at around 55% of GDP over the coming two years. GG debt will rise to 31% of GDP in FY19 from 29% in FY16, mostly due to the birr devaluation. SOE debt has declined to 25.8% in FY17 from 28% of GDP in FY16, one quarter of which is owed by the national railway company. We expect it to reduce further to 24% of GDP in FY19. The government is attempting to curtail additional borrowing by SOEs and has established new mechanisms to monitor their financial commitments. Ethiopia's consistent record of rapid economic growth and future growth potential is a credit strength. We expect GDP to expand by an average 9.5% in FY17-FY19, well above the 'B' median of 3.5%. Growth has proved robust to the recent drought and political unrest to date. It is supported by strong investment under the FY15/FY20 Growth and Transformation Plan II and robust inflows of FDI. Sturdy investment and sustained urbanisation are supporting activity in the construction and services sectors, while industrial supply is expanding. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Ethiopia a score equivalent to a rating of 'BB-' 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: - Public finances: -1 notch, to reflect the indebtedness of SOEs which is not captured in the model and represents a significant contingent liability to the sovereign. -External finances: -1 notch, to reflect the high level of net external debt relative to 'B' medians and low foreign currency reserves against the background of a structural current account deficit and managed exchange rate. 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 main factors that could, individually or collectively, lead to positive rating action, are: - Stronger external finances with an acceleration in exports leading to lower current account deficits and higher foreign currency reserves. -Decline in public sector debt/GDP resulting from continued restraint on SOE borrowing and/or moderate budget deficits in the context of strong economic growth. -Improvement in the government's financing flexibility resulting, for example, from a stronger mobilisation of private domestic resources, higher supply of concessional funding or lengthening of the maturity profile of non-concessional debt. The main factors that could, individually or collectively, lead to negative rating action, are: - Political instability, particularly if it leads to macroeconomic spill-overs such as disruptions to FDI, lower growth or fiscal slippages. - Rising external vulnerability, such as a failure of export growth to accelerate leading to the persistence of wide current account deficits and low foreign exchange reserves. - Sizable increase in government indebtedness or crystallisation of contingent liabilities from SOEs on the sovereign's balance sheet. KEY ASSUMPTIONS We expect global economic trends and commodity prices to develop as outlined in Fitch's Global Economic Outlook. The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'B'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'B'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'B' Short-Term Local-Currency IDR affirmed at 'B' Country Ceiling affirmed at 'B' Issue ratings on long-term senior unsecured foreign-currency bonds affirmed at 'B' Contact: Primary Analyst Mahmoud Harb Director +852 2263 9917 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Ed Parker Managing Director +44 20 3530 1176 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Applicable Criteria Country Ceilings Criteria (pub. 21 Jul 2017) here Sovereign Rating Criteria (pub. 21 Jul 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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