Cabo Verde weighed down by debt

Cabo Verde’s long-term foreign-currency issuer default rating (IDR) has been kept at B-, with a stable outlook, due to its deteriorating debt metrics.

The country’s rating reflects its very high public and external indebtedness, large sovereign contingent liabilities, and the economy’s high dependence on tourism.

Moderate public debt interest service and very long average debt maturity stemming from access to official concessional financing, and stronger governance indicators relative to peers support the rating.

The coronavirus disease 2019 (COVID-19) crisis resulted in a historic economic contraction in 2020 and a sharp increase in already high government debt levels.

Fitch forecasts growth of 4.5% in 2021 and 6.4% in 2022, after a 14.8% contraction in 2020. The easing of domestic and international crisis-related restrictions since mid-2021 will support a stronger recovery of the tourism sector, 25% of gross domestic product (GDP) and demand in 2022.

Downside risks stem from developments in the coronavirus, including from the new Omicron variant.

Cabo Verde’s strong vaccination rollout, with 53% of the population having received at least one dose by early December, may help mitigate this risk and aid growth over the coming quarters.

Fitch estimates the fiscal deficit to remain wide at 9.6% of GDP in 2021, up from 9.1% in 2020 and above the forecast deficit of 7.1% for the B median, before narrowing to a forecast 4.9% in 2022.

The baseline scenario for 2021 incorporates revenue weakness and continued support measures, as well as projected higher public investment relative to 2020.

The sharp reduction in the deficit in 2022 will be driven by the recovery of the tourism sector, the phasing out of both tax holidays and pandemic-related social, and health spending.

Downside risks to the fiscal outlook stem from a more prolonged economic weakness weighing on government revenues.

On the other hand, expenditure under-execution, most notably of capital spending, could ease financing requirements.

The authorities are also considering raising the  value added tax (VAT) rate if the country fails to obtain an extension of the debt service suspension in 2022.

Fitch estimates that government gross financing needs, deficit plus debt amortisations and below the line spending, will reach 15.1% in 2022, down from 16.2% of GDP in 2021.

A combination of domestic market issuance, external financing from official creditors and potential debt service suspension from bilateral creditors, 2.6% of GDP, will allow government financing requirements to be met.

Cabo Verde completed its policy coordination instrument (PCI) programme with the IMF in early 2021 and is reportedly negotiating a new PCI programme.

The country has a long record of receiving technical and financial support from official creditors.

 

Fitch expects gross government debt to rise to 157% of GDP in 2021 and then gradually decline to 146% by 2023, still more than double the projected 70% of GDP B median.

The high share of multilateral and official bilateral creditors, 73% of external debt, contributes to a relatively low interest payments of 2.8% of GDP, similar to B median in 2021. This is despite higher debt and a long 20-year average maturity.

Cabo Verde’s participation in the G20’s debt service suspension initiative (DSSI) has led to savings of 0.8% of GDP, CVE1.4 billion, in 2020 and an estimated 1.7% of GDP in 2021.

The authorities are exploring debt relief alternatives for the country’s multilateral and official bilateral debt. The country does not have any outstanding Eurobonds.

Government contingent liabilities are also high. Fitch estimates total SOE liabilities at around 50.4% of GDP in 2021, including 11.5% of GDP in government guarantees.

The rating agency estimates total government guarantees to have reached 13.3% of GDP in 2021. This stood at 7.9% in 2019, mostly reflecting support to Cabo Verde Airlines, as well as partial guarantees to support local companies’ access to credit during the crisis.

The government re-nationalised Cabo Verde Airlines in July, effectively reversing its 2019 privatisation.

Investors in the privatisation have indicated they intend to take the country to arbitration.

Fitch forecasts the current account deficit to remain in double digits, 12.6% of GDP, in 2021 before declining to 9.5% in 2022.

This reflects a pickup in export demand, a modest recovery in tourism revenues and transport services, as well as continued resilience in remittances.

The level of external indebtedness will remain high due to the large external deficit and the government’s fiscal needs.

Fitch expects net external debt to jump to 84% of GDP in 2023, more than double the 33% for the B median.

Cape Verde’s international reserve coverage will remain stronger than peers, and sufficient to support the currency the peg.

This represents 6.5 months of current external payments in 2021, and external liquidity, 227.8% in 2022, measured by the ratio of the country’s liquid external assets to its short-term external liabilities.

The long-standing peg to the euro provides an anchor to macroeconomic and financial stability and is facilitated by a liquidity facility from Portugal.

Banco de Cabo Verde has lowered its policy rate to near zero and provided liquidity to the domestic economy, including long-term facilities.

Fitch expects the central bank to maintain a supportive policy stance given low inflation, continued low interest rates by the ECB and the absence of pressures on the peg.

 

The banking sector has maintained adequate solvency, capital adequacy ratio of 20.9% in the third quarter of 2021, and liquidity conditions.

Non-performing loans, excluding credits under moratorium, declined to 9% at end-2021 but asset quality risks remain. A credit moratorium extends to 20% of total loans and is scheduled to expire in March 2022.

Fitch would downgrade the rating if there were increased fiscal financing constrains or signs that any potential public debt forgiveness or restructuring would affect private sector creditor liabilities.

The rating agency would also downgrade the rating if there were a sharp erosion in FX reserves. This would be due, for example, to insufficient external financing to cover the current account deficit or further delays in the return of tourism receipts.

Fitch would upgrade the rating if there was greater confidence in a sustained reduction in the debt to GDP ratio over the medium term. For example, due to stronger economic growth, fiscal consolidation and reduced risk of contingent liabilities.

The rating agency would also upgrade the rating if there was a significant improvement in medium-term growth prospects resulting, for example, from increased FDI and expansion of the tourism sector.

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