Seychelles slides on debt woes

Seychelles’ long-term foreign-currency issuer default rating (IDR) has been downgraded from B+ to B, by Fitch Ratings due to rising debt.

Fitch has however kept Seychelles’ outlook at stable on the expectation that the country’s economic growth will recover in the near-term.

The stable outlook also reflects the country’s moderate near-term commercial external debt repayment schedule, and a good track record of adherence to International Monetary Fund (IMF) programme.

General government debt is forecasted to rise to 86.5% of gross domestic product (GDP) at the end of 2020. This is from 50.5% at the end of 2019, well above the projected B median of 63.8%.

Fitch excludes debt issued for monetary purposes, about 8.6% of GDP as these treasury bills are fully backed by deposits at the Central Bank.

The weaker Seychellois rupee has contributed to the increase in general government debt, 49.6% of which is foreign currency-denominated.

Fitch projects debt peaks at 95.8% of GDP at the end of 2021, 17.3% higher than the rating agency previously forecasted, before falling to 89.3% at the end of 2022.

The 2020 financing needs have largely been met through domestic sources, close to 85% of total. This is mainly through treasury bills, and three, five and seven-year bonds worth approximately $68.2 million (SR1.5 billion) or 7.5% of GDP.

Seychelles’ government plans further heavy reliance on net domestic issuance in 2021 and 2022 but there is greater uncertainty over the capacity of the domestic market to absorb this.

The net external debt-to-GDP is also rising rapidly to a forecast 85.6% of GDP at the end of 2021. This is from 33.4% at the end of 2019, well above the peer group median of 32.8% of GDP.

This is driven by the exchange rate depreciation, fall in nominal GDP, reduction in private sector assets, and increase in sovereign external debt.

There is greater uncertainty over external financing sources next year. Planned international finance institution budget support and project loans cover only around one-quarter of the current account deficit plus foreign direct investment (FDI).

Existing external debt service totals $51.4 million in 2021 and $54.1 million in 2022, 50% of which is private sector, mainly Eurobond payments.

External financing was boosted this year by $31 million from the IMF and $22 million from the World Bank. However, international finance institution budget support is set to fall next year, and no Eurobond is planned.

GDP is forecasted to contract by 15.5% in 2020, due to the collapse in tourism, which accounts for an estimated 25% of GDP or 55% if indirect factors are included.

Growth in the canned tuna sector, large fiscal stimulus, 200 basis points (bp) of interest rate cuts, and robust credit growth have provided some support to economic activity.

Fitch has revised down its 2021 GDP growth forecast by 2% to 5% on expectations of a more gradual pick-up in tourism in the first half of 2021.

The rating agency’s projection for GDP growth to accelerate to 6.5% in 2022 reflects the resumption of FDI and benefits of vaccination. This is alongside the low base in tourist numbers and a view that Seychelles’ high-end tourism model provides greater insulation from structural impacts from the coronavirus disease 2019 (COVID-19) shock.

The general government deficit is projected to widen to 19% of GDP in 2020, from close to balance last year, the highest in the B rating category. This is 3.9% higher than Fitch previously forecasted, partly reflecting the extension into the fourth quarter of 2020 of wage subsidies, which total 6.5% of GDP in 2020.

Fitch has also revised up its 2021 deficit forecast by 7.4% to 14.1% of GDP, which incorporates the government’s plan for further employment measures in the first half of 2020. This also incorporates support for the state-owned transportation company Air Seychelles of close to 3.5% of GDP.

The rating agency expects the deficit to fall to 9.1% of GDP in 2022, in line with a stronger economic recovery and withdrawal of the fiscal support package.

There is a risk of additional crystallisation of contingent liabilities, which are estimated at close to 19% of GDP. This includes liabilities from Air Seychelles, where $71.5 million debt owed to United Arab Emirates-based transportation company Etihad is currently being restructured.

Fitch expects the current account deficit to widen to 30.5% of GDP at the end of 2020, from 16.4% in 2019 and the highest in the B rating category.

A near 60% fall in tourism revenues, which accounted for around three-quarters of foreign exchange (FX) receipts in 2019, is partly offset by import compression including from a forecast 75% drop in net FDI.

FX reserves have fallen by less than expected, to $563 million at the end of November, from $594 million in February.

Central bank FX interventions were limited to supporting the normal functioning of the market, totalling $29 million this year. This is in the face of the sharp depreciation to $1/SR21.2 from $1/SCR13.9 in mid-March.

Fitch expects the current account deficit to steadily narrow to 22.3% of GDP at the end of 2022, with recovering tourism demand also helped by the weaker Seychellois rupee.

Net FDI is expected to recover to 12.0% of GDP in 2022 from 5.3% in 2020, and FX reserves to fall to 2.5 months of current external payments. This is from 4.7 months at the end of 2020, below the projected B median of 4 months.

On the upside, Seychelles’ GDP per capita, governance, and human development indicators are much higher than the peer group medians. The country also has a strong track record of stable fiscal balances coming into this crisis, averaging 0.2% of GDP surplus in 2015 to 2019.

Set against these factors are Seychelles’ small and undiversified economy, structural current account deficit, high external debt, volatile GDP growth and vulnerability to external shocks.

Seychelles’ banking sector entered the crisis well capitalised and profitable, which will help absorb the expected deterioration in asset quality.

Local currency credit grew 6.5% year-on-year in October, but we expect that greater pressure on capital positions will impair lending, constraining the pace of economic recovery.

The sector tier 1 ratio fell to 15.4% in October, from 17.1% in March. The non-performing loan ratio has remained low and relatively stable at 2.6%, although Fitch expects it to rise markedly over the next year.

Fitch would consider upgrading Seychelles if general government debt-to-GDP returned to a firm downward path over the medium term and a reduction in external vulnerabilities.

The rating agency would downgrade the rating if there are more acute balance of payment pressures leading to a larger fall in FX reserves and higher external debt ratios.

Failure to place general government debt-to-GDP on a firm downward path over the medium term would also lead to a downgrade, according to Fitch.

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

See full rationale here