Botswana hit by fiscal pressures


Botswana’s long-term local and foreign currency issuer ratings have been dropped from A2 to A3 by Moody’s Investors Service, on deteriorating fiscal strength.

Moody’s has however revised Botswana’s outlook from negative to stable, on the expectation that its credit metrics will remain commensurate with the A3 rating. This is notwithstanding the risks posed by the evolution of the coronavirus disease 2019 (COVID-19) crisis and a potentially weaker than currently expected recovery in the demand for diamonds.

The stable outlook also reflects Moody’s expectations that prudent macroeconomic policies will continue. This will help Botswana to navigate the challenges stemming from the country’s economic model reliant on the diamond industry and on a large public sector.

Botswana’s fiscal buffers have eroded, exacerbated by the COVID-19 crisis, reducing the government’s ability to absorb future shocks, which the country is more exposed to than most of its A-rated peers.

Fiscal measures to cushion the effect of the COVID-19 crisis and the large shock to revenue, primarily due to a reduction in mineral revenue, led to deterioration in fiscal metrics.

Moody’s estimates the fiscal deficit to have reached 9% of gross domestic product (GDP) in fiscal 2020, compared with 5.6% in 2019.

Botswana’s government financed the 2020 deficit mainly by drawing down fiscal reserves and to a lesser extent by issuing domestic debt.

As a result, Moody’s expects government debt, excluding guarantees to have only increased to about 19% of GDP in fiscal 2020, up from 14.7% in 2019.

Fiscal reserves in Government Investment Account (GIA), which represents the government share of foreign exchange reserves in the Pula Fund and Liquidity Portfolio, declined by about 80%, since the shock. This dropped to 1.9% of GDP at the end of 2020, from 9.3% in March 2020, exacerbating a downward trend, from 17.1% of GDP in 2017 and 24.3% in 2015.

The erosion of fiscal buffers reduces the government’s capacity to absorb future shocks to which the country is more exposed than most of its peers in the A rating category. This is due to relatively weaker economic resilience, mainly reflecting a lower level of income and economic diversification.

This is exacerbated by significant reliance on volatile sources of revenue, with mineral and Southern African Customs Union (SACU) revenue accounting for more than half of total revenue pre-crisis.

In addition, expenditure composition is sticky given the high wage bill, representing about 40% of total expenditure.

Botswana’s external buffers are also weakening, although from a strong level. The current account position has worsened in recent years, driven by the deterioration of the trade balance. In 2019, the current account balance shifted into a large deficit.

Moody’s estimates that the deficit widened further to around 10 % of GDP in 2020 and foreign-exchange reserves declined to $4.8 billion. This is equivalent to about 13 months of non-diamond imports or 9 months of total imports at the end of 2020, down from $6 billion in 2019.

COVID-19 has also exposed the structural limitations of Botswana’s growth model, characterised by the large presence of the public sector and exposure to fluctuations in global demand for diamonds. The diamond sector accounts for 15% of GDP and around 90% of goods exports.

After expanding by 3% in 2019, real GDP contracted by 7.9% in 2020, a deeper contraction than for most Sub-Saharan African sovereigns and A-rated peers. This is as a result of restrictions imposed on economic and social activity to contain COVID-19 and the fall in global demand for diamonds and subsequent production cuts.

Travel restrictions significantly affected Botswana’s tourism sector, which contributed 5% of GDP directly pre-crisis.

Moody’s expects the economy to recover in 2021, with real GDP expanding by 6.2%, mainly driven by the rebound in mining industry and gradual normalisation of domestic economic activity.

Despite the downside risks to the post-crisis fiscal consolidation path, Moody’s expects that Botswana’s financial strength will remain commensurate with the A3 rating in the near to medium term.

Moody’s also expects that susceptibility to event risk will remain contained given low political risk, limited government liquidity and external vulnerability risks and a stable banking sector.

The rating agency expects that solid institutions will continue to pursue prudent policies delivering macroeconomic stability and helping with the challenges posed by the country’s economic model.

However, over the longer term, the absence of material diversification progress risks eroding Botswana’s credit strengths.

Moody’s would consider upgrading Botswana’s rating if there is improved resilience to shocks supported by higher buffers or reduced vulnerabilities of the budget structure.

The rating agency may consider downgrading the rating if there is a marked deterioration of fiscal metrics beyond Moody’s current expectations.

Meanwhile, Moody’s has lowered Botswana’s local-currency country ceiling by one notch, from Aa2 to Aa3.

Moody’s has also lowered Botswana’s foreign-currency country ceiling by one notch, from Aa3 to A1.

This comes after S&P Global Ratings dropped Botswana’s outlook from stable to negative, on deteriorating fiscal metrics, on the back of COVID-19 crisis.

See full rationale here