Ethiopia hit by default fears

Ethiopia’s long-term issuer and senior unsecured ratings have been pulled down from Caa1 to Caa2, with a negative outlook, by Moddy’s Investors Service, on default risks.

Ethiopia’s local currency (LC) country ceiling has been lowered from B2 to Caa1, while the foreign currency (FC) country ceiling has also been lowered – from Caa1 to Caa2.

The rating reflects increased default risks which have increased in the absence of significant developments and prospects of a near-term resolution of its application for common framework debt treatment.

This is also partly as a result of the country’s inability to access official or market-based external funding which has raised external liquidity risks significantly pointing to a possible default.

Continued heightened social tensions and conflict in Ethiopia have weakened the quality of the country’s institutions and governance.

This further impairs the country’s ability to secure external funding, which is essential to shore up its very thin foreign exchange reserves.

The negative outlook reflects heightened uncertainty regarding political risks and the common framework’s resolution. It also reflects the risk of material losses to investors in the event of a default by Ethiopia beyond what would be consistent with a Caa2 rating.

There is a high degree of uncertainty about the potential losses for private sector creditors in the event of a possible default.

Nevertheless, there is a material possibility that the creditor committee decides on a debt treatment.

This may involve losses consistent with a lower rating and by the time the creditor committee’s decision is taken, liquidity risks may have increased further. This may necessitate a more significant reprofiling of Ethiopia’s debt.

Moody’s assessment is that non-diversifiable risks are appropriately captured in a LC ceiling one notch above the country rating.

This is taking into account the extensive footprint of government in the economy, with very limited private sector activity including a very large state-owned enterprise sector. This also includes government ownership of the majority of the banking system, as well as a weak institutional framework and high political and external vulnerability risks.

The one-notch gap between the FC and LC ceiling reflects Moody’s assessment of material transfer and convertibility (T&C) risks. This is given a relatively closed capital account, constrained access to foreign exchange and external imbalances which could lead the government to impose T&C restrictions.

Since Ethiopia formally entered the common framework for debt treatment beyond DSSI last February, no tangible developments have occurred other than the formation of a creditor committee in September.

Moody’s expects the creditor committee’s decision on what debt treatment to apply to take some time, during which period Ethiopia has no access to official and market-based external funding.

As a result, liquidity risks have heightened, and default risk increased to levels more consistent with a Caa2 rating.

Moody’s understands that the timing of future deliberations of the creditor committee is circumscribed by at least a staff-level agreement on a new extended credit facility (ECF) with the IMF.

This includes a refreshed debt sustainability analysis (DSA), which introduces new delays to the process beyond the control of the authorities.

The protracted period taken for official creditors to start discussing, and eventually agree on a debt treatment suggests complex negotiations which raises the risk of private sector creditors being involved.

While at this stage there is no indication about the potential losses for private sector creditors, Moody’s assesses that, the risks have increased with the passage of time without a resolution.

Moreover, the longer the common framework conclusion is pending, the longer Ethiopia remains without agreed new external concessional funding and without access to market-based financing.

Liquidity risks, which were at the origin of Ethiopia’s application for common framework debt treatment, are increasing, also contributing to higher default risk.

The government has issued a first spectrum license and a new bid has been launched for a second. However, such measures only provide partial and temporary liquidity relief in the absence of access to external financing.

The government finances its deficit through domestic sources, which is has managed to-date through increasing recourse to central bank financing.

However, external debt and import payments risk eroding further already low foreign exchange reserves, equivalent to less than two months of import cover.

Continued heightened political risk in Ethiopia also contributes to the downgrade. In the past year, long-standing tensions have escalated to outright conflict.

The situation has put the much-needed economic reforms announced by the prime minister in 2018 on hold and has reversed some of the early 2020 gains of the IMF’s 2019 programme.

Domestic political risks are exacerbated by the coronavirus disease 2019 (COVID-19) shock which is projected to slow real gross domestic product (GDP) growth to 2% in 2021.

This retarded domestic revenue mobilisation and slowed foreign exchange accumulation, worsening two of Ethiopia’s longstanding credit challenges of low revenue and thin foreign exchange reserves.

The political situation is complex, reflecting enduring ethnic tensions, which are unlikely to be resolved in the foreseeable future.

Heightened domestic political risks manifest in the war in the Tigray region as well as uprisings spreading into the Afar, Amhara, and Oromia regions.

There is now a concerning humanitarian situation with over two million displaced persons. In response, some development partners are withholding development aid resources while others have threatened sanctions in a bid to prompt a response from the government.

Such deep tensions and conflict are likely weighing on some creditors’ ability and readiness to provide financing or debt relief, further contributing to default risk.

An upgrade of Ethiopia’s rating is unlikely given the negative outlook and before full clarity is obtained on the conclusion of the common framework creditor committee.

However, a common framework conclusion pointing to no or very limited losses for private sector creditors would lead to a rating upgrade.

Over time, evidence that political stability and peace are durably restored across the country would also lead to an upgrade. This is especially so if such an environment pointed to a material improvement in government revenue and foreign exchange reserves.

Moody’s would downgrade the ratings were it to conclude that losses to private sector investors would exceed those consistent with a Caa2 rating level.

This comes after Ethiopia’s long-term foreign and local currency sovereign credit ratings were lowered to CCC+ from B- with a negative outlook, by S&P Global Ratings, earlier in 2021.

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