Moody’s downgrades Ethiopia’s rating to B2; rating on review for further downgrade

ADDIS ABABA (Capital Markets in Africa) — Moody’s Investors Service (“Moody’s”) has downgraded the long-term issuer and senior unsecured ratings of the Government of Ethiopia to B2 from B1 and placed the ratings on review for further downgrade.

The downgrade to B2 reflects heightened external and government liquidity risks further aggravated by the coronavirus outbreak which has severely hit the economy’s foreign currency receipts, raised the government’s spending needs, and curtailed its financing options. Ethiopia is more exposed to these shocks than many peers due to its high ratio of external public sector debt to foreign exchange reserves.

The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and financial market turmoil are creating a severe and extensive economic and financial shock. Moody’s regards the coronavirus outbreak as a social risk under its ESG framework. For Ethiopia, this shock manifests mainly in lower exports and foreign direct investment receipts and larger external financing needs.

The review for downgrade reflects Ethiopia’s stated intention to seek official sector debt service relief under the recently announced G20 initiative. Suspension of debt service obligations to official creditors would be unlikely to have rating implications; indeed relief from official debt service obligations would allow fiscal resources to be devoted to essential health efforts and social spending, while also reducing external and government liquidity pressures. However, the G20 has called on private sector creditors to participate in that initiative on comparable terms. The review period will allow Moody’s to understand how the apparent tension will be resolved between the government’s stated desire to engage only with official sector creditors and the G20’s call for private-sector creditors to participate. It will assess whether Ethiopia’s participation in that initiative will indeed be implemented without private sector participation and, if not, whether any losses expected to arise from that participation would be consistent with a lower rating.

The long-term local currency bonds and bank deposits ceilings remain unchanged at Ba3. The long-term foreign currency bonds ceiling has been lowered to B2 from B1, and the bank deposits ceiling has been lowered to B3 from B2.

The Rationale for the downgrade to B2
Coronavirus shock heightens external vulnerability risks
The downgrade to B2 is prompted by the significantly negative effect of the coronavirus outbreak on Ethiopia’s already fragile external position. The risks of the severe balance of payments stress have increased.

With sectors essential to the country’s generation of foreign currency revenue through exports, such as international travel and transport and horticulture very severely hit by the slump in international demand and restrictions to the movement of people, Ethiopia’s external financing needs have risen, at the same time at which FDI inflows have dwindled, privatization receipts will be delayed and emergency healthcare imports increased.

Moody’s expects the current account deficit to widen to 6% of GDP in the fiscal year 2020, from 5.3% in fiscal 2019, while FDI inflows will likely fall below 2% of GDP. As a result, Moody’s estimates that Ethiopia’s external financing requirements will rise to close to 8% of GDP in fiscal 2020 and 2021. Notwithstanding the country having already secured some financing with further likely to come from multilateral and bilateral organizations, there remains a sizeable external financing gap this year and next. These elevated requirements place pressure on foreign reserves that are already low at below two months of import cover; total external debt is more than 8 times the level of foreign exchange reserves at end-2019.

The coronavirus shock also adds downward pressure to Ethiopia’s weak public finances. After years of very strong GDP growth around 8-10%, government revenue to GDP stands at less than 13% of GDP in fiscal 2019 and is likely to fall with the current sharp growth shock. Moody’s forecasts GDP growth to slow to 4% in 2020. For the early part of fiscal 2020, expenditure was constrained, but with added health and social spending related to combating the coronavirus outbreak and its economic effects, current expenditure will increase. While ongoing government measures to raise revenue and improve tax administration showed some tentative positive results in the months leading up to the coronavirus shock, the effectiveness of these measures will be significantly delayed by the economic and social impact of the outbreak. The very narrow revenue base raises significant policy challenges to the government about how to maintain its debt service commitments while providing essential healthcare and social spending.

In general, the global shock poses significant hurdles to the government’s reform implementation efforts aimed at arresting the decline in government revenue generation and the rise in state-owned enterprise external debt as it pursues its broader strategy to transform the economy from a state-centered and controlled economy to a market economy and fortify the country’s fiscal strength and foreign-exchange generation capacity.

The Rationale for initiating a review for further downgrade on B2 ratings
The review for downgrade reflects Ethiopia’s stated intention to seek debt service relief under the recently announced G20 initiative. This initiative offers benefits for the world’s poorest nations, many of which are highly externally indebted and exposed to outflows of capital and depreciating exchange rates during an unprecedented crisis. Additional financial support and liquidity relief will allow precious fiscal resources to be devoted to essential health efforts and towards minimizing the economic impact of the crisis. However, the G20 has called on private sector creditors to participate in that initiative on comparable terms. That suggests that, for the countries that elect to seek official sector debt service relief, the initiative may also lead to the suspension of payments or renegotiation of private-sector debt service obligations.

Ethiopia has a financing plan over the next two fiscal years, which relies heavily on significant and urgent disbursements from the international community in order to meet increased government borrowing requirements and significantly higher external financing needs.

The review period will allow Moody’s to understand how the apparent tension will be resolved between the government’s stated desire to engage only with official sector creditors and the G20’s call for private-sector creditors to participate. It will assess whether Ethiopia’s participation in that initiative will indeed be implemented without private sector participation — an outcome which could lead to the rating being confirmed at its current level — and, if not, whether any losses expected to arise from that participation would be consistent with a lower rating.

Besides the considerations about losses to private-sector creditors in debt service relief measures, the risks to Ethiopia’s credit profile are skewed to the downside, relating to the potentially severe implications of a persistent external financing gap, further downward pressure on foreign exchange reserves and the exchange rate and threats to macroeconomic stability.

Environmental, social and governance considerations
Environmental considerations are material to Ethiopia’s economic strength and credit profile. Given the prominence of agriculture in the economy and reliance on rainfall for irrigation and hydroelectric plants, recurring droughts can have a significant negative impact on the agriculture and energy sectors.

Social considerations are also material to the rating. High-income inequality and high levels of poverty have the potential to fuel social discontent. Moreover, Moody’s regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety globally. For Ethiopia, the pandemic shock manifests in heightened external vulnerability.

Governance considerations are material to Ethiopia’s credit profile. Weak governance in particular amongst some state-owned enterprises (SOEs) has contributed to high SOE debt which, if left unchecked, could result in a further deterioration in the credit profile.

What could lead to confirmation of the rating at the current level
The rating would likely be confirmed at its current level should Moody’s conclude that participation in multilateral or bilateral debt service relief would be unlikely to entail default on private sector debt or, if it would, that any losses experienced would be likely to be minimal.

Besides the considerations about losses to private-sector creditors in debt service relief measures, ongoing material pressure on Ethiopia’s external position and fiscal metrics could be consistent with a negative outlook at B2, while prospects of a durable stabilization in Ethiopia’s external position would likely be consistent with a stable outlook at B2.

Factors that could lead to a downgrade
The rating would likely be downgraded should Moody’s conclude that participation in the G20 debt service relief initiative would probably entail default on private sector debt and that losses experienced would be likely to exceed the threshold consistent with a B2 rating.

Moreover, an intensification of external pressure with materially wider current account deficits than Moody’s currently expects and/or inability to secure sufficient external financing leading to a further marked erosion of foreign exchange reserves would also likely lead to a downgrade.

Given the significant increase in Ethiopia’s external vulnerability associated with the coronavirus shock, this event prompted the publication of this credit rating action on a date that deviates from the previously scheduled release date in the sovereign release calendar, published on www.moodys.com.

• GDP per capita (PPP basis, US$): 2,511 (2019 Estimate) (also known as Per Capita Income)
• Real GDP growth (% change): 9.0% (2019 Estimate) (also known as GDP Growth)
• Inflation Rate (CPI, % change Dec/Dec): 14.5% (2019 Actual)
• Gen. Gov. Financial Balance/GDP: -2.6% (2019 Estimate) (also known as Fiscal Balance)
• Current Account Balance/GDP: -4.8% (2019 Estimate) (also known as External Balance)
• External debt/GDP: 28.1.2% (2019 Estimate)
• Economic resiliency: ba3
• Default history: At least one default event (on bonds and/or loans) has been recorded since 1983

On 4 May 2020, a rating committee was called to discuss the rating of the Government of Ethiopia. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have materially decreased. The issuer’s fiscal or financial strength, including its debt profile, has materially decreased. The issuer’s susceptibility to event risks has materially changed.