Congo | Moody’s downgrades Republic of the Congo’s rating to B1

Brazzaville, Congo, Capital Markets in Africa —  Moody’s Investors Service has today downgraded the Republic of the Congo’s (ROC) issuer rating to B1 from Ba3 and placed the B1 rating under review for further downgrade.

The downgrade reflects the severe deterioration in the government balance sheet caused by the significant fall in oil prices, which Moody’s expects to remain low for several years. The purpose of the review for further downgrade is to allow Moody’s to assess the government’s ability to mitigate any further negative impact of the lower oil price on ROC’s credit standing.

Concurrently, Moody’s has lowered ROC’s country and deposit ceilings to Ba1 from Baa3. The rating downgrade drove the change in ceilings.

Moody’s expects to complete the review within two months.

RATING RATIONALE 
RATIONALE FOR DOWNGRADING ROC’S RATING TO B1

The key driver behind Moody’s decision to downgrade ROC’s rating to B1 is the severe deterioration in the government balance sheet caused by the fall in oil prices. Moody’s recently revised its oil price assumptions for Brent to US$33 per barrel in 2016 and US$38 per barrel in 2017, rising only slowly thereafter to US$48 by 2019. Government finances in ROC are particularly susceptible to this drop in oil prices because of two inter-related factors: first, oil-derived revenues account for a particularly large share of total revenues (69% in 2014); and second, the ‘super profit’ structure of contracts widely used in the country’s oil sector translates into oil-derived revenues being particularly sensitive to oil price variations.

The structural shock to the oil market is weakening ROC’s government balance sheet. Moody’s estimates that the government debt position net of deposits deteriorated by around 13 percentage points of GDP in 2014 and 27 percentage points in 2015. The rating agency expects a further deterioration of around 20 percentage points in 2016. During 2014-15, the government has substantially drawn down its fiscal reserves, which are in the form of deposits held at the central bank and in banks. In 2015, these government deposits reached 23% of GDP versus a gross debt of 46% of GDP.

Under its medium-term (2016-18) baseline scenario for ROC’s government finances, Moody’s assumes a certain degree of fiscal consolidation in accordance with the government’s response to the oil price shock in 2015. However, ROC’s adjustment capacity remains relatively limited from an institutional and financial standpoint and disproportionate to the magnitude of the structural shock. Factors that limit the shock absorption capacity of the government include modest fiscal reserves and very low institutional strength in a pre-electoral context. In particular, national authorities face a policy trade-off between growth and fiscal outcomes given the economic importance of public investment. The government’s capital expenditures represented a high 65% of total expenditure or 31% of GDP in 2014 and are likely to be the main target for cuts and fiscal consolidation.

Moody’s notes that ROC’s government entered the period of protracted low oil prices with a strong balance sheet, recording a net creditor position in 2013, with liquid fiscal reserves (deposits) exceeding gross debt. However, under Moody’s baseline scenario, ROC’s government debt will exceed liquid fiscal reserves by 43% of GDP in 2016 and net debt will reach 48% of GDP by 2017. These debt metrics reflect a material weakening in the government’s financial strength, which has historically been ROC’s main credit support.

The rating agency considers the government’s finances to be the key transmission channel of the oil price shock to the sovereign’s creditworthiness. Moody’s expects that the Congolese economy will suffer, although not in the short-term because oil production will increase, but rather in the medium term given that the oil sector accounts for a large share of the economic base, or 56% of GDP.

On the external side, ROC’s reliance on oil exports is also substantial as oil-related exports account for more than 80% of exports and roughly 51% of GDP in 2014, according to the United Nations Conference on Trade and Development (UNCTAD). However, risks continue to be mitigated by its membership of the franc Zone, a monetary union whose currency is pegged against the euro with a guarantee from France’s fiscal authority. Moody’s projects that the current account deficit in % of GDP will reach double digit in 2016.

RATIONALE FOR THE REVIEW FOR FURTHER DOWNGRADE 
The key factors informing Moody’s decision to review ROC’s B1 rating for further downgrade are the downside risks to ROC’s government finances beyond the trend Moody’s has incorporated in the rating downgrade to B1. Fiscal funding requirements could therefore be greater than expected and prove more difficult to secure.

The rating review will allow Moody’s to assess the government’s ability to mitigate the impact on ROC’s credit standing. In particular, the review will assess the clarity, scope and ambition of the government’s plans relative to the scale of the task, the time required for them to bear fruit, and the reliance that can therefore be placed on them to sustain ROC’s credit strength. As part of the review, Moody’s will also assess the government financing strategy for the coming years and the impact it has on ROC’s liquidity risk. It will also assess the credit support offered by ROC’s membership of the franc Zone during this period of depressed oil prices.

Inflation has been limited thanks to ROC’s membership of the franc Zone. However, the foreign exchange reserves of the monetary union (CEMAC) that are held at the central bank (BEAC) have been under pressure because five of the six member countries in the union, including ROC, are oil exporters.

Moody’s expects to conclude its review of ROC’s rating within two months.

WHAT COULD RESULT IN A DOWNGRADE 
Moody’s would further downgrade ROC’s rating if its rating review were to conclude that the government’s plans are unlikely to be adequate to sustain ROC’s government balance sheet strength consistent with the new B1 rating level. Any further downward adjustment to the rating would most likely be limited to one further notch.

Signs of an emerging fiscal or balance-of-payments crisis would also exert downward pressure on the rating. Those signs might include a further sustained fall in the oil price, sustained capital outflows and pressure on the exchange rate and foreign-currency assets, as well as a marked worsening in the fiscal balance for which no clear reversal was in sight. That said, given ROC’s membership of the franc Zone, the risk of a balance-of-payments crisis is more limited than it is in other oil-exporter countries that do not benefit from such an arrangement. A deterioration in the domestic or regional political environment, resulting in fiscal slippages, would also be highly credit negative.

WHAT COULD STABILIZE THE RATING AT THE CURRENT LEVEL 
Moody’s would maintain and confirm ROC’s B1 rating if the rating review were to conclude that there is evidence of an emerging clear, credible fiscal and economic policy response, which offers the prospect of containing the deterioration in the fiscal balance and government balance sheet in line with the baseline scenario captured by today’s decision to lower the rating to B1.