Ethiopia dropped on default woes

Ethiopia’s long-term foreign and local currency sovereign credit ratings have been dropped from B to B- on default concerns, by S&P Global Ratings.

The rating agency has also placed Ethiopia’s rating on creditwatch negative due to the risk that the country might include commercial creditors in its government debt restructuring plans.

Exacerbated by the effects of the coronavirus disease 2019 (COVID-19) crisis, Ethiopia’s structurally weak external balance sheet has deteriorated further, in S&P’s view.

Ethiopia intends to restructure its bilateral country debt under the G20’s Common Framework for Debt Treatment Beyond the Debt Service Suspension Initiative (DSSI). The country could also seek debt relief from commercial creditors as part of the process.

The G20’s Common Framework, unveiled in November 2020, aims to reduce participating countries’ unsustainable debt levels via debt relief obtained from both bilateral and private creditors on comparable terms. It remains unclear whether, under the framework, participants will be obliged to undertake private sector debt restructuring.

S&P understands that the Ethiopian government is reviewing the sustainability of its public debt, with the assistance of the International Monetary Fund (IMF), to initiate discussion with official lenders.

The government could extend broader debt treatment discussions to commercial creditors depending on the outcome of negotiations with bilateral lenders.

S&P’s credit ratings reflect its view of a country’s capacity and willingness to service its commercial obligations. The private sector participation in the restructuring would result in a default.

The rating agency estimates Ethiopia’s public debt repayment needs at about $5.5 billion over 2021-2024, including a $1 billion Eurobond due in 2024.

S&P expects Ethiopia’s external debt net of liquid external assets to increase to above 275% of current account receipts through 2024, compared with about 115% in 2014.

Overall public sector external debt, including the National Bank of Ethiopia’s (NBE) foreign deposit liabilities is about 10x gross foreign exchange reserves.

Ethiopia’s external liquidity needs are also high. S&P expects the country’s gross external financing needs to average in excess of 170% of current account receipts and usable reserves over 2021 to 2024.

These high refinancing needs exceed the country’s foreign exchange reserves of about $3 billion. The quality of the foreign exchange reserves is low, reflected by NBE’s external liabilities surpassing foreign assets by about $1 billion according to official data from June 2020.

Ethiopia’s weak external metrics make it a continual underperformer among 35 similarly rated countries.

Given the COVID-19-induced economic pressure, S&P expects Ethiopia’s real gross domestic product (GDP) growth to slow to about 1% in 2021, from an estimated 6.1% in the 2020 fiscal year.

 

The COVID-19 crisis will more adversely affect Ethiopia’s economy in 2021, compared with the 2020 fiscal year – partly due to slow vaccine deliveries.

Potential shocks to economic activity could be exacerbated by risks to the agriculture sector.

Although Ethiopia’s economy is dominated by services, with about 40% of GDP, the agriculture sector contributes a substantial 33% – and agricultural products account for over 55% of merchandise exports.

The rating agency expects Ethiopia’s economic growth to rebound to about 5% in 2022.  This is down from 9% on average over the five years to 2019 due to moderating public investment growth and tightening monetary conditions.

S&P expects real GDP growth to slow to a still-high 6% to 6.5% annually through 2024.

Despite Ethiopia’s steady economic expansion, the ratings remain constrained by low GDP per capita, which is estimated at about $1000 in 2021.

Ethiopia’s external balance sheet remains weak due to elevated external debt, despite S&P’s expectation of narrower current account deficits compared with the recent past.

Due to persistent fiscal deficits and continued depreciation of the Ethiopian birr, S&P expects net government debt will remain close to 30% of GDP over the forecast horizon. Highly indebted state-owned enterprises (SOEs) pose rising contingent liability risks.

S&P projects the current account deficit at 6.7% of GDP in the 2021 fiscal year and will gradually decline to 5% through 2024, having averaged 9% in the six years to 2020. This is largely supported by contained imports on limited external borrowing for new public projects, gradual export growth and diversification, and recovery in private remittances.

The rating agency expects current account deficits over the forecast horizon to be largely funded through net foreign direct investment and capital grants.

Nevertheless, S&P expects foreign direct investment inflow to fall to about 2.5% of GDP on average over 2021 to 2024, from 4% in the six years to 2020.

Multilateral and bilateral support, including through the IMF assistance and potential debt restructuring under the G20 Common Framework, could enable Ethiopia maintain external liquidity levels. This will also enable the country to limit the need to draw heavily from foreign currency reserves.

The IMF’s funding package unlocks financing of about $2.7 billion over the program’s duration after a rephasing of disbursements.

Nevertheless, the country’s foreign exchange reserves remain among the lowest of rated countries, amounting to about two months of current account payments.

Amid the COVID-19-induced economic slowdown, which will weigh on revenue, S&P expects Ethiopia’s fiscal deficit will expand to about 3.4% of GDP in the 2021 fiscal year. This is before shrinking to about 2% of GDP through to the 2023 fiscal year.

Revenue enhancement measures and some public investment rationalisation will support fiscal improvements from 2022.

The government intends to undertake various tax policy measures, including introduction of a new excise tax regime in 2020, the removal of value-added tax (VAT) exemptions from 2021.

S&P expects the government to finance budget deficits through a combination of concessional external loans and domestic debt.

The rating agency expects the government to continue mobilising concessional funding if the impact of COVID-19 results is higher-than-budgeted social expenditure.

Given persistent fiscal deficits and continued depreciation of the birr, S&P projects gross general government debt will average above 32% of GDP over 2021-2024. A large share of the government’s debt is concessional.

General government direct commercial debt amounts to about 7% of GDP, and the external portion includes a $1 billion Eurobond issue due in 2024.

A high proportion of central government debt – about 70% is in foreign currency. This could further increase the risk of a debt increase due to sharp exchange-rate depreciation, according to S&P.

Although direct general government debt is still moderate, overall public-sector debt, including SOEs’ guaranteed debt is estimated at 60% of GDP. This exposes the government to contingent liabilities risks.

S&P expects SOEs’ net borrowing requirement will gradually decline over the IMF funding program’s duration.

Some SOEs’ external loan facilities guaranteed by the sovereign, including a $4 billion loan for the railway project, were re-profiled in 2018 to 2019.

Ethiopia’s crawling peg exchange regime limits NBE’s monetary policy flexibility and the ability of the economy to adjust to external shocks.

The birr exchange rate remains under increased stress due to a persistently negative trade balance and crisis-related lower foreign currency inflows from tourism and travel services and remittances.

The premium between the official and market exchange rates in the parallel market exceeds 30%. The official exchange rate was devalued by about 18% over fiscal 2020.

Due to trade disruption, birr deprecation, and seasonal factors, S&P estimates headline inflation at about 20% in 2020.

The NBE’s monetary policy is likely to accommodate temporary inflationary pressures due to supply shocks, but S&P expects it will move to a significant tightening cycle once the crisis abates.

The rating agency expects inflation will decline gradually to 13% by 2024.

S&P could eventually lower the ratings further if the government undertakes a debt exchange offer, which it would consider a distressed debt exchange based on its criteria.

The rating agency would also consider a downgrade if it concludes that Ethiopia is unwilling or unable to service the interest payments on its commercial obligations.

S&P could affirm the rating if it becomes clear that Ethiopia’s commercial obligations will not be included in the upcoming debt restructuring.

This comes after Fitch Ratings lowered Ethiopia’s long- and short-term foreign currency sovereign credit ratings from B to CCC, on default concerns, earlier in 2021.

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