DRC lifted by mining growth

The Democratic Republic of Congo’s (DRC) outlook has been uplifted from stable to positive by Moody’s Investors Service, on expectations of robust economic growth driven by the mining sector.

This upgrade reflects DRC’s robust economic prospects driven by the mining sector and potential for improved economic resiliency from the implementation of structural reforms under the IMF program.

The positive outlook also reflects the increase in official foreign currency reserves which are set to continue to accrue over the coming years. This may reduce the exposure to downturns in commodity prices and the severe episodes of macroeconomic volatility associated with them.

Moody’s has however kept DRC’s long-term issuer ratings at Caa1, as the country struggles with low wealth levels, very weak institutions, and weak economic shock absorption capacity.

The affirmation of the rating also reflects the country’s high political risk against low and affordable government debt.

Notwithstanding a strong economic recovery on the back of the mining sector, public finances remain vulnerable to commodity prices volatility.

Moody’s expects the DRC’s extractive sector to continue playing a pivotal role in the economy as a main source of growth in the future. This is amid strong global demand for its main exports, namely copper and cobalt.

This follows the strong performance in the past year, with the mining sector growing 9.7% and more than compensating for the 1.3% contraction of the rest of the economy. This was in the wake of the coronavirus shock.

Copper production reached a record level at almost 1.6 million tons last year compared to 1.1 million in 2017.

With the Kamoa-Kakula mine, the continent’s largest copper mine project already ahead of schedule, DRC’s copper production is set to exceed 2.5 million tons over the next decade.

Moody’s expects that DRC’s real GDP growth is likely to exceed 6% on average over the 2021 to 2025 period.

This is supported by the rapid development of its mining sector and conducive prices for DRC’s main exports.

Furthermore, the authorities’ commitment to implement the structural reforms included in the three-year $1.5 billion IMF program will support growth further and help to strengthen economic resilience overall.

An area of focus is domestic revenue mobilisation, which is a key credit constraint for the DRC. The government is generally forced to constrain expenditures to avoid any fiscal slippages that would otherwise stoke inflation.

Over the period of the program anchored on no central bank financing, government revenues are set to steadily increase by more than four percentage points to reach 14% of GDP in 2025.

The program contains an array of reforms to achieve this objective including modernising the revenue administration, fixing valued added tax (VAT) to increase its efficiency and scope.

It also includes rationalising non-tax and parafiscal charges at all tiers of government and streamlining tax expenditures previously estimated at around 20% of revenues.

Other objectives include the control on government spending, strengthening the monetary policy framework and the level of foreign exchange reserves, and improving the business environment.

The growing mining sector offers the prospect of significant increases in both fiscal revenues and export earnings as production volumes rise. Any small deficit over the period will be fully funded by the financing package provided by the international financial institutions (IFIs) under the umbrella of the IMF.

Meanwhile, Moody’s has also affirmed DRC’s local currency (LC) country ceiling t B3, while the foreign currency (FC) country ceiling has been kept at Caa1.

The one-notch gap between the LC ceiling and the country rating reflects a high degree of unpredictability of government actions. It also reflects domestic political risk, as well as the significant exposure of the economy to mining sector.

On the other hand, the one-notch gap between the FC ceiling the LC ceiling reflects limited policy effectiveness and the relatively low openness of the capital account and convertibility risks. This is given the track record of exchange rate volatility during episodes of commodity price shocks.

The improvement in DRC’s external position is evident in the stabilisation of the exchange rate and growing foreign exchange (FX) reserves.

FX reserves now stand above $3 billion as of end of September, up from $0.7 billion in 2020. This had increased by close to $700 million during the first nine months of 2021.

This was mainly due to the performance of the mining sector and further benefitting from the $1.5 billion SDR transfer from the recent increased allocation for all IMF members.

Moody’s expects DRC’s gross official foreign exchange reserves to reach at least $5 billion at the end of 2025. This is corresponding to around five months of imports cover and the current account deficit.

The current account deficit has been narrowing in the years since 2013 with the development of the mining sector and was estimated around 2.3% of gross domestic product (GDP) in 2020, to continue to narrow.

This may help to reduce the country’s exposure to downturns in commodity prices and the severe episodes of macroeconomic volatility associated with them.

The lack of foreign exchange reserves during past commodity price downturns has been the driver of a depreciation of the Congolese franc. This was followed by the monetisation of the deficit by the central bank given the loss of government revenues.

DRC’s credit profile remains constrained by very weak institutions, infrastructure deficiencies and high political risk.

Moreover, the mining sector continues to dominate the economy despite the agriculture and hydroelectricity sectors’ large potential for growth.

As a result, DRC is vulnerable to periods of low commodity prices causing economic downturns, large drops in government revenue and a weakening of the country’s fragile external position.

 

Current conditions offer the prospect of significantly higher levels of government revenues and foreign exchange reserves being achievable in the coming years.

However, the prospect of a higher rating hinges on the implementation of reforms that would increase confidence that the improvement in credit fundamentals will prove enduring.

DRC’s credit supports include its robust medium-term growth prospects and substantial natural resources base.

In addition, the imposition of relatively tight budgetary controls has averted significant fiscal slippages for almost two decades.

This has resulted in a very low and affordable government debt burden below 15% of GDP. Therefore, the government probability of default remains quite low despite the economy remaining inherently vulnerable to shocks.

Moody’s would consider an upgrade of DRC’s ratings if the ongoing implementation of structural reforms supported by the IMF program led to stronger institutions and higher economic shock-absorption capacity.

The rating agency would also upgrade the rating if the current period of favourable economic conditions and commodity prices served to sufficiently rebuild the country’s foreign-exchange reserves.

Moody’s would also consider a rating upgrade if the favourable economic conditions served to rebuild DRC’s fiscal buffers to smooth the impact of future episodes of macroeconomic volatility.

A rating downgrade is unlikely at this point given the positive outlook. However, Moody’s would stabilise DRC’s outlook if the implementations of structural reforms and the anticipated improvements in the credit fundamentals do not materialise.

Economic or political shocks that would contribute to macroeconomic instability, including pressure on the currency that would raise the government’s debt burden, could also lead to stabilisation of the ratings.

This comes after DRC’s outlook was uplifted to positive from stable by S&P Global Ratings, on expectations of an improvement in its growth prospects, earlier in 2021.

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