DRC hit by liquidity pressures

The Democratic Republic of Congo’s (DRC) outlook has been dropped from positive to stable by Moody’s, on external and budgetary pressures, exacerbated by the  coronavirus disease 2019 (COVID-19) pandemic.

Moody’s has however affirmed the long and short-term foreign and local currency ratings at CCC+/C, as the country has solid medium-term prospects. This is on the back of higher mining production, lower domestic tensions, and renewed relations with the international community.

The rating agency expects the COVID-19 pandemic to take a heavy toll on DRC’s economy and public finances in 2020.

Despite solid prospects once COVID-19 impacts abate, DRC still needs favourable business, financial, and economic conditions, to meet its financial commitments over the medium to long term.

Moody’s expects higher mining production and implementation of reforms to address structural vulnerabilities and diversify the economy, which could boost broad-based growth.

However, the country’s downside risks remain significant, since domestic political stability is fragile and policy making difficult on the back of a complex coalition agreement.

DRC recorded strong performance in 2019, with economic growth reaching 4.4%. However Moody’s expects the pandemic to push the country into a recession, with growth contracting about 2.6% in 2020.

Moody’s also expects measures implemented to curb the spread of COVID-19 to weigh on domestic economic activity.

The rating agency expects the budget deficit to widen in 2020, but significant multilateral and bilateral emergency financial assistance should mitigate the adverse impact of the pandemic.

The COVID-19 pandemic will weigh on the country’s budget, via lower revenue and economic activity.

Higher financing needs since the beginning of the year and limited financing options have led to the monetary financing of the budget deficit until the end of April 2020.

Lower exports, over 95% of which come from the mining sector and inflows of foreign direct investment (FDI) will further weaken the country’s already very fragile external position.

The rating agency expects reserves to fall, from an already low level, to less than four weeks of imports.

To preserve scarce buffers, the central bank, agreed with the International Monetary Fund (IMF) to limit interventions in the foreign-exchange market to defend the currency. The currency has already depreciated by about 15% between January and early July 2020.

The rating agency expects inflation to surge in 2020, breaking from the recent downward trend. Inflation had declined to about 5% on average in 2019 following an average of over 30% in 2018 and 2017.

However, external pressures that led to the depreciation of the Congolese franc should push up inflation to about 14% in 2020. This is in addition to central bank financing of the budget deficit between January and April.

DRC’s debt management has historically been weak. Most of DRC’s external debt of $3.7 billion consists of restructured debt and multilateral debt. It also has guaranteed debt of $2.6 billion relating to Sicomines, a DRC-based mining company, and $1.9 billion of central administration domestic debt.

DRC’s government still has domestic arrears, such as wages owed to past government employees, contractors, suppliers and unpaid Treasury bills issued in the 1980s.

The country also has reported arrears to some external creditors, including some foreign commercial banks.

However, Moody’s considers these defaults to be a legacy issue because they have likely been written-off by the creditor banks. The original creditors sold their claims to distressed debt investors.

In 2014, a New York court upheld the claim of two US-based investors, Themis Capital and Des Moines Investments against DRC and BCC for non-payment of some of this debt.

DRC has committed to pay $13 million to Themis Capital and Des Moines Investments by 2021, and is current on this obligation. There are only three payments left, one in 2020 and two in 2021.

On the upside, DRC has reacted quickly to the COVID-19 pandemic, supported by the IMF’s $442 million financing package provided in April 2020.

Moody’s expects growth to resume at a relatively solid pace over the next few years, notably on the back of the mining sector.

DRC’s mining sector represents approximately 25% of the country’s gross domestic product (GDP) and 95% of exports.

Following the long-delayed presidential elections, and despite widespread accusations of fraud and lack of transparency, domestic tensions have lowered since the beginning of 2019.

IMF concluded its first Article IV consultations in the country since 2015, approving a staff monitored program (SMP). This came along with a special drawing right (SDR) of $370 million under the revolving credit facility (RCF) to address urgent balance-of-payment needs.

A substantial increase in public investment, in line with President Felix Tshisekedi’ priorities should support growth in the coming years, according to the rating agency.

Moody’s expects higher financing needs stemming from a higher deficit and lower-than-planned Treasury bill issuances to be covered by bilateral and multilateral partners.

In April 2020, the IMF provided about $363 million in emergency funding via the revolving facility.

The DRC is also one of the 25 countries receiving grants from the IMF to cover its debt service from April to October 2020.

DRC’s debt service of SDR14.9 million falls due in the initial period of debt service relief and SDR29.7 million in the 24-month potential extension period.

The World Bank also approved $1 billion to support the education and health sector. The financing comprises $800 million to support free primary school education and $200 million to improve maternal and child health. This includes $435 million in grants and $565 million in concessional loans.

In addition, DRC will participate in the G20 debt service moratorium initiative.

The central bank, Banque Centrale du Congo (BCC) has also implemented measures to support the DRC’s economy during the pandemic. The bank reduced the policy rate by 150 basis points (bps) to 7.5% and eliminated mandatory reserve requirements on demand deposits in local currency.

BCC also created a new collateralised long-term funding facility for commercial banks of up to 24 months to support the provision of new loans.

The central bank has also postponed the adoption of new minimum capital requirements and encouraged the restructuring of non-performing loans.

Moody’s expects external and budgetary tensions to lessen once the effects of COVID-19 soften.

The general government balance should record a small deficit over the next few years, as the new administration may need to spend more on social welfare to limit domestic tensions.

Moody’s forecasts revenue will mainly evolve in line with copper and cobalt prices and production levels. The recently enacted mining code should support an increase in mining revenue.

Imports will increase on the back of higher domestic demand, public investments, and demand for services from the mining sector.

Moody’s may consider a downgrade if budgetary and external tensions continue to increase and foreign-exchange reserves are on a downside trajectory.

The rating agency may also downgrade DRC if domestic or security tensions escalate, threatening the countries already-weak institutions and fragile economy.

Moody’s may consider an upgrade if DRC secures sufficient structural external financial support from international partners and continues to make payments on commercial debt on time and in full.

See full rationale here