(The following statement was released by the rating agency) PARIS/LONDON, October 09 (Fitch) Fitch Ratings has affirmed Ethiopia's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'B'. The Outlooks are Stable.
The issue ratings on senior unsecured foreign currency bonds have also been affirmed at 'B'. The Country Ceiling and the Short-term foreign-currency IDR have been affirmed at 'B'. KEY RATING DRIVERS Ethiopia's 'B' IDRs reflect the following key rating drivers: Ratings are well entrenched in the 'B' rating category due to weak development and governance indicators.
Despite rapid improvement over the past five years, Ethiopia's income per head and human development indicator remain among the lowest of Fitch-rated sovereigns, even among 'B' rated peers, illustrating weak debt tolerance. Driven by massive public investment by the government and state-owned enterprises (SoEs), growth has averaged close to 10% over the past five years in real terms, including 8.7% in FY15 (ending in July 2015).
This has led to a rapid improvement in living standards and progress towards meeting Millennium Development Goals. However, this has come at the expense of a rise in indebtedness of the broader public sector. The government's cautious fiscal stance prevailed in FY15, with the budget deficit likely to have been contained at 2.7% of GDP, and government debt broadly stable at a moderate 26.3% of GDP, lower than 'B' rating peers.
Nonetheless, SoE public debt has risen materially in recent years, particularly in FY15, to an estimated 25.6% of GDP at end-FY15, a large share of which is non-concessional. This brings the consolidated debt of the government and SoEs to an estimated 52% of GDP at end-FY15, 55% of which is external.
Although the authorities expect SoE debt to be repaid from commercial receipts, in Fitch's view it represents a rising contingent liability for the central government. Domestic vulnerabilities remain important rating drivers, including high and volatile inflation, as well as a rapid rise in credit. The drought resulting from unusually low rainfall in 2015 has pushed food prices up, bringing inflation up to 11.4% yoy at August 2015, and creates economic risks for next year.
Credit (mostly to SoEs) has also risen very fast, triggering a score of '3' in Fitch's macro-prudential indicator assessing potential systemic stress, and lending is often at negative real interest rates. The banking sector, dominated by the public sector, is sound and profitable but heavily exposed to a limited number of SoEs, on which there is limited transparency.
Weak export performance (exports of goods and services declined by an estimated 6.6% in FY15) associated with dynamic capital goods imports has led to the current account deficit deteriorating to an estimated 13% of GDP in FY15 (FY14: 8.6%). This largely reflects the weak and concentrated export base but also weak competitiveness partly caused by an increasingly overvalued exchange rate. The IMF estimates the real effective exchange rate appreciated by 21.4% in FY15 alone, which suggests it could now be around 30% above its equilibrium level.
As a result, net external debt jumped to an estimated 25% of GDP at end-FY15 (FY10: 12.1%), higher than 'B' medians. International reserves have historically been particularly low, at just two months of current external receipts at end-FY15. Together with the rise in external debt and the overvaluation of the birr, this increases the risk of exchange rate adjustment.
The central bank's ability to continue depreciating the currency by only 5% a year in nominal terms will critically depend upon the economy's ability to generate FX in the coming years. The recent pick up in FDI and energy export prospects are promising in that regard but the low exports of manufactured products so far, which the government intends to develop in the coming years, illustrate the challenges to industrialization (including weak business environment and access to credit for private companies).
However, Fitch believes that the potential negative impact of currency devaluation on government debt would be manageable, given the relatively modest increase in the debt stock that it would imply. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently balanced.
The main factors that could, individually or collectively, lead to positive rating action, are: -Stronger external indicators reflected in higher exports, stronger FDI and international reserves. -Further structural improvements, including stronger development and World Bank governance indicators. -Further improvement in the macro-policy environment, supporting moderate inflation and a transition to broader-based growth.
The main factors that could, individually or collectively, lead to negative rating action are: -Rising external vulnerability, illustrated by declining international reserves, further widening of the current account deficit or rising external indebtedness. - A further rapid increase in public sector indebtedness or increased risk of contingent liabilities from SoEs and publicly-owned banks materialising on the state's balance sheet.
KEY ASSUMPTIONS Fitch assumes that world GDP will grow by 2.7% in 2016 and 2017, supporting Ethiopia's exports of goods and services. Fitch assumes that Brent crude will average USD55 and USD60 per barrel in 2015 and 2016 respectively, therefore alleviating pressures on the current account deficit.
Source: Reuters
