Cape Verde bolstered by good debt structure

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Cabo Verde’s long-term foreign-currency issuer default rating (IDR) has been affirmed at B- by Fitch Ratings, on favourable debt structure.

Fitch has also kept Cabo Verde’s outlook at stable, as the country has strong governance indicators.

Cabo Verde’s rating is bolstered by its moderate public debt interest service and very long average debt maturity.

This stems from good access to official concessional financing, and stronger governance indicators relative to peers.

Fitch estimates that government gross financing needs will reach 18.1% of gross domestic product (GDP) in 2021.

Domestic market issuance, gross 6.3% of GDP, and net 3% of GDP, in line with the current legal limit, and external financing from official creditors will accommodate government requirements. This is in addition to debt relief through the Debt Service Suspension Initiative (DSSI), 1.8% of GDP.

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

Nevertheless, the availability of external financing on concessional terms will also decline as Cabo Verde transitions to middle-income status.

Fitch forecasts growth to reach 5.5% in 2021 and 6.4% in 2022, after a 14.8% contraction in 2020.

A strong pipeline of hospitality sector foreign direct investment (FDI), which saw construction activity restart in September, public investment and the large negative output gap, will support near-term growth.

Containment measures were tightened in March to deal with the second wave of the coronavirus disease 2019 (COVID-19) crisis. The tourism sector, which accounts for 25% of GDP will only begin the recovery phase in second half of 2021.

Economic prospects are dependent on the evolution of the crisis in Cabo Verde and key export markets.

The number of new cases has declined, but the vaccination campaign has faced delays, with 5% of the population vaccinated at early June, due to global supply constraints.

Cabo Verde’s rating is weighed down by very high public and external indebtedness, large sovereign contingent liabilities and the economy’s high dependence on tourism.

The COVID-19 crisis resulted in a historic contraction in 2020 and a sharp increase in already high government debt levels.

Fitch forecast the fiscal deficit to remain high at 10% of GDP in 2021, up from 9.1% in 2020 and above the 6.2% B median.

Gross government debt rose to 155% of GDP in 2020 and is the third highest among Fitch-rated sub-investment-grade countries.

The high share of multilateral and official bilateral creditors, 73% of external debt, contributes to a relatively low external debt service, 6.7% of current external receipts (CXR). This is compared with a B median of 19.5% in 2021 and a long 20-year average maturity.

Fitch forecast debt to rise above 156% of GDP in 2021 before declining gradually to 151% in 2022 and 129% by 2026, maintaining high risks to debt sustainability.

Cabo Verde’s participation in the G-20’s DSSI has led to savings of approximately $15.3 million (Esc1.4 billion) 8% of GDP in 2020. This has also led savings of Esc2.8 billion, 1.6% of GDP in the first half of 2021, with an additional 1%, if extended until end-2021.

The country is exploring restructuring alternatives on its multilateral and official bilateral debt. The sovereign does not have any outstanding Eurobonds.

Cabo Verde’s government’s contingent liabilities are also high. Total state owned enterprise (SOE) liabilities were estimated at 49.1% of GDP at end-2018, including 2.4% of GDP owed to the government, and 6.8% in government guarantees.

Government guarantees rose to 10.5% in 2020, 7.9% in 2019, mostly reflecting support to transportation company, Cabo Verde Airlines, partly privatised in 2019. The government has also provided partial guarantees to support local companies’ access to credit during the crisis.

Fitch expects the current account deficit to remain in double digits, 12.9% of GDP in 2021, before declining to 6.3% in 2022.

This is on the expected export demand pick up, a modest recovery in tourism revenues, after a 64% year-on-year contraction in 2020 and transport services and continued resilience in remittances.

A high external deficit, slow resumption of FDI inflows and the governments’ fiscal needs will maintain a high level of external indebtedness.

Net external debt jumped to 74% of GDP in 2020, more than double the 33% for the B median countries.

Despite increased external vulnerability, international reserve coverage, 6.5 months of current external payments (CXP) in 2021 and external liquidity, 241% will remain stronger than peers.

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

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

The rating agency expects the central bank to maintain a supportive policy stance given low inflation, at 0.4% year-on-year in April and the absence of pressures to the peg.

Cabo Verde’s banking sector maintained adequate solvency, capital adequacy ratio at 19.4% at the end of 2020 and liquidity conditions.

BCV instructed banks to postpone distribution of dividends. Non-performing loans excluding credits under moratorium declined to 9.4% at the end of 2020, but asset quality risks remain. The credit moratorium reaches 20% of total loans and is scheduled to conclude in September 2021.

The rating agency would consider upgrading Cabo Verde’s rating if there is a significant improvement in medium-term growth prospects and greater confidence in a sustained reduction in the debt-to-GDP ratio.

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

This comes after S&P dropped Cape Verde’s rating from B to B-, on rising external and budgetary financing imbalances, earlier in 2021.

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