Fitch Ratings has affirmed Ethiopia’s Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘B’. The issue ratings on senior unsecured foreign currency bonds are also affirmed at ‘B’. The Outlooks on the Long-term IDRs are Stable. The Country Ceiling and the Short-term foreign currency IDR are also affirmed at ‘B’.
KEY RATING DRIVERS
Ethiopia’s ‘B’ IDRs reflects a balance between the economy’s high exposure to weather and commodity price shocks, as illustrated by particularly weak development and governance indicators, and strong economic growth associated with improved public and external debt ratios since debt relief under HIPC in 2005-2007.
More specifically, they reflect the following key rating drivers: -Development and World Bank governance indicators remain weak despite impressive achievements of the authorities’ development strategy in the last decade, illustrating low debt tolerance and entrenching the IDRs in the ‘B’ rating category. Income per head remains among the lowest of Fitch-rated sovereigns. -Macroeconomic performance is broadly in line with peers. After outperforming peers with an average 10.2% over the past five years, real GDP growth is likely to reach 9%-10% in FY15 (ending in early July 2015), as authorities maintain a large public investment effort. Structurally high and volatile inflation has moderated to single-digits over the past 18 months (February 2015: 7.4%), due to moderate domestic and international food prices and reduced recourse to central bank financing.
General government’s fiscal stance has remained cautious. Given adequate budget execution over the first seven months of the fiscal year, Fitch estimates that the authorities’ FY15 target of a deficit of 2.9% of GDP is achievable. Public debt will likely moderately increase to 27.1% of GDP (FY14: 26%) following a USD1bn bond issue in December 2014 but will remain below peers. Although the share of foreign-currency debt is significant (56% at December 2014), Fitch believes that risks to public debt sustainability in the short- to medium-term remain moderate, due to its largely concessional nature, low interest rates and long maturity.
Despite favourable general government metrics, Fitch deems public finances neutral to the ratings as a significant part of fiscal risks are transferred to state-owned enterprises (SoEs), which have historically borne a large share of public investment cost. Their consolidated debt has materially increased in recent years to 22% of GDP at end-June 2014 from 12.1% in 2010. As they already absorb the lion’s share of limited domestic credit (29% of GDP at end-June 2014), they have increasingly turned to external, sometimes non-concessional, sources in recent years. The authorities expect this debt to be repaid from commercial receipts, but Fitch views this as a rising contingent liability for the government for which data availability remains limited.
The banking sector is sound with NPLs of around 3% of gross loans; however, risks could emerge from its large and concentrated exposure to SoEs and from rapid expansion in domestic credit (30% yoy in December 2014). This is reflected in a score of ‘3’ on Fitch’s macro-prudential indicator of potential systemic stress.
Weak FX generation is a constraint on the ratings given the rising foreign-currency indebtedness of the government and SoEs (which cumulatively reached 22% of GDP at end-June 2014). International reserves, at 1.8 months of current account payments at end-June 2014, are structurally stretched, although they have since started to improve on the back of the bond issue and lower international oil prices. However, with an expected current account deficit of 7.6% of GDP in FY15, and limited signs of export diversification and FDI pick-up so far, Fitch expects international reserves will remain vulnerable and external debt to continue rising in coming years. Nevertheless, this may be mitigated by an improvement in the export base and composition over the medium term following the completion of the Gile Gibe III and the Renaissance dams and as the government focuses on export promotion.
The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the ratings are currently well-balanced. The main factors that could, individually or collectively, lead to a positive rating action, are: -Stronger external indicators reflected in higher exports, stronger FDI and international reserves -Further structural improvements, including stronger development and World Bank governance indicators -Further improvement in the macro-policy environment, supporting moderate inflation and a transition to broader-based growth The main factors that could, individually or collectively, lead to a negative rating action are: -Rising external vulnerability, illustrated by declining international reserves, further widening of the current account deficit or rising external indebtedness -Increased risk of contingent liabilities from SoEs and publicly-owned banks materialising on the state’s balance sheet
Fitch assumes that the ruling coalition EPRDF will remain in power after the general elections due in May 2015 and therefore no major changes to the political regime and development model of the country in the coming years. Fitch assumes that world GDP will grow by 2.7% in 2015 and 3% in 2016, supporting Ethiopia’s exports of goods and services. Fitch assumes that Brent crude will average USD65 and USD75 per barrel in 2015 and 2016 respectively, compared with an average USD101 in 2014, improving the current account deficit and international reserves in both years.