Tunisia downgraded on weak governance

Tunisia’s long-term foreign-currency and local-currency issuer ratings have been dropped from B3 to Caa1 by Moody’s Investors Service, on weakening governance.

Moody’s has also kept Tunisia’s outlook at negative due to downside risks related to possible protracted delays in reforms and reform-dependent funding which would erode foreign exchange (FX) reserves.

Meanwhile, Tunisia’s local-currency country ceiling has been lowered to B1 from Ba3, while the foreign-currency ceiling was lowered to B3 from B2.

The downgrade reflects weakening governance, in particular lower quality of Tunisia’s institutions, significantly raising liquidity risks which could lead to default over time.

Tunisia’s large external imbalances and reliance on continued inflows limits the degree to which reserves can be drawn down further without jeopardising currency and price stability.

The negative outlook reflects downside risks related to possible protracted delays in reforms and reform-dependent funding which would erode FX reserves. This would be through drawdowns for debt service payments, thereby exacerbating balance of payment risks.

In this scenario, the probability of a public sector debt restructuring that would entail losses for private sector creditors would arise.

Continued uncertainty regarding the institutional framework reduces the prospect for structural fiscal and economic reform. This hinges on renewed access to official and commercial funding sources to meet the government’s upcoming funding needs.

The recent formation of a new government led by Prime Minister Najla Romdhane sets the stage for renewed negotiations with official and bilateral lenders.

However, a consensus on long-standing reforms, including the public sector wage bill, energy subsidy reform and reform of state-owned enterprises, will be challenging to secure among stakeholders.

Such reforms are critical to rebalance Tunisia’s fiscal accounts and ensure debt sustainability in the future amid a subdued growth outlook.

External and domestic liquidity conditions have tightened significantly in the wake of the constitutional crisis, leading to uncertainty regarding the government’s capacity to meet its upcoming funding needs.

Moody’s fiscal deficit estimate of 7.7% of gross domestic product (GDP) in 2021 and 5.9% in 2022 implies gross borrowing requirements of about 18% of GDP this year and 16% in 2022.

Budget execution data to July 2021 show an execution rate of 30% for external borrowings, reflecting prohibitive financial market access, spreads have widened to over 1000 basis points.

This is with a budgeted $2.3 billion, 5.2% of GDP, outstanding through this channel. The government may seek alternative sources of funding such as bilateral loans and a drawdown of the IMF’s recently allocated Special Drawing Rights amounting to $740 million.

On the domestic side, a renewed increase in commercial banks’ refinancing needs at the central bank indicates increasing absorption constraints.

For 2022, renewed access to multilateral and bilateral loans will most likely rely on the successful negotiation of an IMF program that has remained elusive since the previous four-year program was cancelled in April 2020.

In the short term, the Caa1 rating remains supported by the $7.8 billion foreign exchange reserve buffer as of September 2021. This offers a backstop for the government’s remaining funding needs this year and estimated external refinancing needs at about $1.5 billion in 2022 before increasing thereafter.

Moody’s expects the debt to GDP ratio to increase to almost 90% of GDP this year from 84.7% in 2020 and stabilising below 95% over the next few years. This is considering a weaker than previously expected economic expansion by 3.5% this year, followed by 2.5% thereafter.

The rating agency expects the affordability of the debt stock to decline amid increasing borrowing costs. On the other hand, the high foreign currency share of government debt, at over 65%, exposes the debt trajectory to adverse currency movements.

In addition, outstanding guarantees to state-owned enterprises at over 15% of GDP in 2020 add to contingent liability risks.

Given the negative outlook a rating upgrade is unlikely, according to the rating agency. However, Moody’s would likely lift the outlook to stable.

This is if it concluded with sufficient confidence that the government’s economic and fiscal reform implementation capacity would lead to a stabilisation and eventual reduction in the debt trajectory.

Moody’s would maintain the rating if Tunisia demonstrated ability to access official and capital market funding at affordable costs to meet its upcoming debt service payments in the next few years.

Conversely, Moody’s would downgrade the rating if constraints on the availability or cost of funding persist. This would be potentially related to further protracted negotiations for a new IMF program and insufficient progress on reform implementation.

Increased external vulnerability risks that result in currency depreciation pressures that keep the debt burden rising higher and for longer than expected would raise debt sustainability concerns. This would also increase the likelihood of a public debt restructuring.

This comes after Tunisia’s long-term foreign-currency and local-currency issuer ratings were dropped from B2 to B3 by Moody’s, on governance concerns, earlier in 2021.

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