Cabo Verde buoyed by strong governance

Cabo Verde’s long-term foreign-currency issuer default rating (IDR) has been affirmed at B-, due to the country’s solid performance on governance metrics.

The rating agency has also kept Cabo Verde’s outlook at stable, as the country has enough funding options.

Cabo Verde’s strong governance and performance on the International Monetary Fund (IMF) policy support instrument programme underpins good access to official financing on favourable terms.

The high share of multilateral and official bilateral creditors, with about 72% of debt value contributes to a relatively low debt service burden and a long 17-year average maturity.

Under the G20’s Debt Service Suspension Initiative (DSSI), debt service payments due to official creditors in May to December 2020 of approximately $9.7 million (€8 million) were rescheduled.

An additional €4 million is covered by the DSSI extension to June 2021, with a potential further extension to the end of next year.

Fitch anticipates that the current government could seek increased donor grants or debt forgiveness on its multilateral and official bilateral debt in conjunction with other similarly affected borrower governments.

This will enable it to rebuild fiscal buffers beyond the coronavirus disease 2019 (COVID-19) crisis. Cabo Verde does not have any outstanding Eurobonds.

Extraordinary support measures taken by the Central Bank, Banco de Cabo Verde (BCV) have supported the domestic banking system through the COVID-19 crisis.

Non-performing loans (NPL) had only risen to 11.3% of loans at the end of the third quarter of 2020, from 10.8% at the end of 2019. This was held down by extensive debt service holidays benefiting roughly 20% of private sector loans.

The debt service holiday is expected to last until the end of June 2021. Unless there is a further extension, banks will then need to recognise crisis-hit NPLs. This could lead to an increase in NPLs by roughly 6% of total loans, taking the system’s ratio closer to the previous peak of 18.7% in 2014.

The rating agency sees the banking system as comfortable at regulated capital requirement of 18% of assets. The two largest banks have ample liquidity, and smaller banks have benefited from the BCV’s liquidity lines. This has supported the system’s liquidity, despite depressed debt servicing.

Banks have also experienced some progress in re-establishing US banking correspondence with US banks or through European banks.

However, Cabo Verde’s rating is weighed down by high public and external indebtedness, large sovereign contingent liabilities, and the economy’s high dependence on tourism.

The COVID-19 crisis has resulted in a severe economic contraction in 2020 and a sharp spike in government indebtedness to record levels.

Fitch forecasts that real gross domestic product (GDP) will contract by 14% in 2020, particularly due to the large negative contribution from net exports.

Anti-crisis fiscal measures will provide only limited cushioning to consumption due to the severe impact on tourism, the main growth engine.

The gradual return of tourism activity in 2021 should result in significant base effects for GDP and Fitch forecasts 2021 real GDP growth to be at 8.5%. This is before tapering to 5 % in 2022.

Gross general government debt (GGGD) is the highest across Fitch-rated Sub-Saharan African countries, spiking to 157% of GDP in 2020. This is due to the sharp contraction in GDP and anti-crisis fiscal stimulus measures.

Concessional external financing from multilateral and official bilateral partners has helped address the additional financing needs, roughly 10% of GDP. High liquidity in the banking system has also allowed the government to increase domestic issuance, roughly 3.5% of GDP.

An expected strong rebound in GDP and robust medium-term growth should put GGGD-to-GDP on a downward path towards 151% by 2022.

Government contingent liabilities are also high and likely to rise. Total state-owned enterprises (SOE) liabilities were last estimated at 49.1% of GDP at the end of 2018. This is including 2.4% of GDP owed to the government, and 6.8% in government guarantees.

The government continues to be responsible for servicing €104 million of transportation company Cabo Verde Airlines’ (CVA) old debt prior to its privatisation through a SOE special purpose vehicle.

Fitch expects the current account deficit to spike to 12.5% of GDP in 2020, as tourism receipts plunge by 65%. Goods and services import compression will provide only limited cushioning due to the country’s high dependence on food and capital goods imports.

Emigrant remittances grew by 12% year-on-year in the first half of 2020. These should continue to support the current account balance in 2020 due to generous income support policies across the US and Europe during the crisis.

The 2020 current account deficit has been financed primarily by official external borrowing, while foreign direct investment (FDI) declined by 7% in the first half of 2020. This is owing to temporary suspensions in construction during the economic lockdown.

Official international reserves were relatively unchanged at $740 million at the end of September 2020. However, Fitch forecasts a pick-up in imports and slowdown in external financing in the fourth quarter of 2020. This will result in reserves falling to $673 million – seven months of 2020 current external payments.

Public sector foreign-currency denominated debt constitutes a large 73% of total government debt at end-2019, accentuating risks in the event of depreciation.

Foreign exchange (FX) risks are partly mitigated by a very long 21-year average maturity of the external debt stock and low external debt service. FX risks are also mitigated by a strong track record of the Cape Verdean escudo-to-euro peg that is supported by Portugal.

Nevertheless, based on 2019 data, external debt service will creep up to $110 million by 2025, from $77 million at the end of 2020, as amortisation grace periods end. The availability of external financing on concessional terms will also decline as Cabo Verde transitions to middle-income status.

Fitch forecasts the general government deficit to worsen to 12.9% of GDP in 2020 due to the collapse in tourism receipts and increased expenditure on healthcare, social payments and transfers. This is before narrowing only slightly to 9.2% in 2021.

The 2021 budget envisages a slight 2% increase in nominal fiscal spending, primarily due to planned investments on water and renewable energy projects. This is also due to a limited reversal of 2020 anti-crisis current expenditure.

Fitch would consider upgrading the rating if there is a faster-than-expected medium-term debt-to-GDP reduction, for example due to stronger economic rebound from the COVID-19 crisis.

The rating agency would also consider upgrading the rating if there is significant improvement in medium-term growth prospects.

Fitch would consider downgrading the rating if there are signs of increased fiscal liquidity constraints.

The rating agency may also downgrade the rating if any potential public debt forgiveness or restructuring exercise would affect private sector creditor liabilities.

This comes after Fitch downgraded Cabo Verde’s IDR from B to B-, earlier in 2020, as tourism took a hit from the COVID-19 crisis.

See full rationale here