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Fitch Affirms Ethiopia at 'B'; Outlook Stable
June 8, 2017 / 2:05 PM / 4 months ago

Fitch Affirms Ethiopia at 'B'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, June 08 (Fitch) Fitch Ratings has affirmed Ethiopia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B' with a Stable Outlook. The issue ratings on Ethiopia's senior unsecured foreign-currency bonds have also been affirmed at 'B'. The Country Ceiling has been affirmed at 'B' and the Short-Term Foreign- and Local-Currency IDRs at 'B'. KEY RATING DRIVERS Ethiopia's rating at 'B' is weighed down by low development indicators, significant external imbalances and rapidly increasing state-owned enterprises (SOEs) debt. These weaknesses are offset by low and mostly concessional general government (GG) debt and a track record of robust economic growth. Ethiopia's structural features remain a major credit weakness, with human and economic indicators ranking among the lowest of Fitch-rated sovereigns. At USD1,500, Ethiopia's purchasing power parity gross national income is well below the 'B' median of USD7,720. The long-standing challenges raised by low governance indicators are underscored by the bout of social unrest experienced in 2016, particularly in the populous regions of Oromia and Amhara. The political situation has returned to calm in 2017. The prolongation of the State of Emergency that was proclaimed in October 2016 for the first time in two decades illustrates the persistence of significant underlying tensions, despite the relaxation of some of its provisions. A relapse in political and security conditions, which is not Fitch's baseline scenario, remains a risk over the medium term, and could hamper growth and discourage foreign investments. Ethiopia's average GDP growth in 2012-16 was 9.5%, much higher than the 'B' category median of 3.9%. GDP growth has been little impacted by two severe drought episodes in 2016-2017, reflecting an improvement in macroeconomic stability. This is attributable to a more efficient crisis management framework, higher agricultural productivity and lower dependence on agriculture due to the solid expansion in construction and to a lesser extent, services. Consequently, GDP growth slowed only moderately to 8% in FY16 (ending 7 July 2016) and has recovered to 10% in FY17, according to authorities' estimates. Inflation has also remained contained below 8%. Lifted by high public investment aiming at bridging wide infrastructure gaps and a gradual pick-up in manufacturing, growth is expected to average around 8% over the next three years, below the 11% target set in the authorities' Growth and Transformation Plan II (GTP II) but still much higher than peers. General government finances remain sound. The GG deficit increased slightly to 2.8% of GDP in FY16, below the peer group median of 4.2%. We expect it to remain below the authorities' self-imposed threshold of 3% over the medium term. At 27% of GDP in FY17, GG debt is less than half the 'B' category median of 56.4%. However, taking into account the liabilities of SOEs, public debt is estimated at 57.9% of GDP in FY17, close to the 'B' median for general government debt. As SOEs implemented much of the massive public investment programme, their debt has increased by 12 percentage points of GDP over five years, reaching 31% of GDP in FY17 according to Fitch's estimates, and generating a substantial contingent liability for the sovereign. Fitch expects the aggregate debt of the public sector including SOEs to stabilise over the next three years, due to sustained GDP growth, moderate deficits and a low debt service cost. This forecast also reflects a gradual moderation in capital expenditures, as no additional major infrastructure investments are being considered by the authorities prior to the completion of the ongoing projects. The authorities' intention to limit the additional take-up of non-concessional external loans, in line with the recommendations formulated by the IMF, should also act as a brake on debt accumulation. External metrics are a rating weakness, with persistent high current account deficits (CAD), low international reserve coverage and a currency that is 20%-40% over-valued according to IMF estimates. The CAD narrowed to 8.4% of GDP in FY16 due to higher private transfers, but it remained much higher than the 'B' category median of 5.7%. Fitch expects it to widen to more than 10% of GDP in FY17 due to steady growth in capital goods imports, higher energy prices, a normalisation of transfers and weak export performance. The value of exports has merely stagnated in FY17, despite a partial recovery in USD commodity prices, reflecting a challenging external environment and persistent impediments to cost and non-cost competitiveness. Fitch expects the CAD to narrow only moderately to 7% of GDP by FY19, remaining wide due to a persistent saving-investment imbalance generated by high expenditures on infrastructure coupled with a narrow export base. Exports are expected to pick up gradually, as the country starts to reap the benefits of past investments in export-oriented light industries and infrastructure. In particular, major industrial projects (Hawassa and Bole-Lemi II industrial parks) should reach full production over the next two years, bolstering manufacturing capacity. The Addis Ababa-Djibouti railway connection should reach full capacity over the next year, reducing trade costs. However, risks to export performance remain high as exports are still concentrated in agricultural commodities and hence susceptible to ephemeral market vagaries and weather hazards with the probability of extreme events rising due to climate change. Ethiopia has managed to attract a steady stream of FDI averaging 3% of GDP during the last five years. However, CAD has been mainly financed by debt, with public sector external liabilities including SOEs tripling between FY10 and FY16. In particular, the external debt of SOEs has increased more than ninefold. Barring a significant acceleration in exports, meeting the current investment targets of GTP II, set above 40% of GDP per year over FY18-FY20, risks undermining external sustainability by further raising net external debt. At a low level of two months of current account payments, reserves offer little protection should external liquidity dry up. The risk of forced external deleveraging is low at the current juncture, owing to the closure of the capital account and the high proportion of concessional debt in total external liabilities. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Ethiopia a score equivalent to a rating of 'BB-' on the Long-Term FC IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: - Public finances: -1 notch, to reflect the significant indebtedness of SOEs which is not reflected in the model and represents a significant contingent liability to the sovereign. - Macroeconomic performance: -1, as Fitch estimates that Ethiopia's massive public investment which is lifting growth cannot be maintained over the medium term, due to the attendant risks to external sustainability. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The main factors that could, individually or collectively, lead to negative rating action, are: - Rising external vulnerability, illustrated by a persistence of a wide CAD with a failure of export growth to accelerate. - Sizable increase in government indebtedness or a materialisation of contingent liabilities from SOEs on the government's balance sheet. - Political instability, particularly if it leads to macroeconomic spillovers such as disruptions to donor inflows and/or FDI, lower growth or fiscal slippages. The main factors that could, individually or collectively, lead to positive rating action, are: - Stronger external indicators such as stronger exports, FDI and international reserves. - Further improvement in the macro-policy environment, leading to a transition to broader-based growth, with a solid expansion in the activity of the domestic private sector. - Further structural improvements, including stronger economic development and World Bank governance indicators. KEY ASSUMPTIONS We expect global economic trends and commodity prices to develop as outlined in Fitch's Global Economic Outlook, Contact: Primary Analyst Mahmoud Harb Director +852 2263 9917 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Amelie Roux Director +33 144 299 282 Committee Chairperson James McCormack Managing Director +44 20 3530 1286 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Country Ceilings (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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