Fitch: Redenomination Risk and Sovereign Rating Implications

LONDON (Capital Markets in Africa) – Fitch Ratings says that it is not always possible to say categorically that a sovereign debt redenomination into a different currency would be a default, under Fitch’s sovereign rating criteria. The agency would assess such an event on a case-by-case basis, taking into account all relevant information at the time.

In response to recent investor enquiries, in a new report Fitch sets out some potential scenarios involving redenomination of sovereign debt and explores the potential rating implications of those scenarios.

Fitch would classify a redenomination of sovereign debt as a default if creditors were not fully repaid in the original currency (or given that option), as long as the original currency continued to exist. In such a situation, we would assess that debt obligations were not honoured in full and on time, which would be akin to a missed payment, and a traditional payment default under our sovereign rating criteria.

Fitch would classify a redenomination as a distressed debt exchange (DDE), which constitutes a particular type of default under Fitch’s sovereign rating criteria, if the exchange imposed a material reduction in terms on creditors and it was used to avoid a traditional payment default.

There are some scenarios in which a redenomination of sovereign debt into a different currency would not constitute a default. For example, if the debt exchange was optional and non-tendered bonds were honoured in full according to their original terms; if there was some facility whereby investors continued to be paid in the original currency; or if the original currency ceased to exist so that the new currency became its sole legal successor and the debt conversion resulted in no material loss of terms to creditors with regard to the original terms.

Other implications of a sovereign debt redenomination could include material adverse economic and financial developments such as bank deposit runs, capital flight and the imposition of capital controls; currency mismatches, increased insolvencies, financial dislocation and potential bank failures; economic instability; challenging financing conditions; and heightened political uncertainty. These developments would likely trigger a sovereign rating downgrade by Fitch (of potentially multiple notches), even if the specifics of the case meant that it did not constitute a default under our criteria.

The report also explores the potential impact of redenomination scenarios on a sovereign issuer’s Country Ceiling, the possible different rating treatment of bonds depending on the applicable governing law, and the potential negative spill-overs and rating implications for the remaining members of a currency union in the event of redenomination and exit by a member of an existing currency bloc.