Moody’s Downgrades Namibia’s rating to Ba1, maintains negative outlook

WINDHOEK (Capital Markets in Africa) – Moody’s Investors Service (“Moody’s”) has today downgraded Namibia’s long-term senior unsecured bond and issuer ratings to Ba1 from Baa3 and maintained the negative outlook.

The key factors for downgrading the rating are:

1. Erosion of Namibia’s fiscal strength due to sizeable fiscal imbalances and an increasing debt burden
2. Limited institutional capacity to manage shocks and address long-term structural fiscal rigidities
3. Risk of renewed government liquidity pressures in the coming years

Despite the weakening of its creditworthiness, the country’s key credit metrics in the economic, fiscal and external spheres are currently well aligned with those of Ba1-rated peers. The rating is also supported by the country’s strong growth prospects in the coming years. However, the maintenance of the negative outlook following the downgrade of the rating to Ba1 reflects the risk that the erosion in key fiscal and debt metrics could be more pronounced than currently anticipated, giving rise to significant funding challenges.

Namibia’s long-term local currency bond and bank deposit ceilings were lowered to A2 from A1. The long-term foreign currency bank deposit ceiling to Ba2 from Baa3, and the long-term foreign-currency bond ceiling to Baa2 from A3.

Rating Rationale
First Factor: Erosion of Namibia’s fiscal strength due to sizeable imbalances and an increasing debt burden

The first factor behind Moody’s decision to downgrade Namibia’s rating to Ba1 is the erosion of the government’s fiscal strength, which was previously a key supportive pillar in Moody’s assessment of the sovereign’s credit strength. The public debt burden has risen rapidly over the past several years, from the low level of 26% of GDP when Moody’s first assigned the rating in 2011 to the current 42%. The high share of debt in foreign currency (other than rand) makes the fiscal position vulnerable to a further rapid deterioration in the event of an exchange rate shock, as was the case most recently in 2015. Other sources of potential deterioration are unexpected shortfalls in Southern African Customs Union (SACU) revenues relative to forecasts as well as expenditure over-runs in the context of upcoming SWAPO leadership elections (end-2017) and presidential elections (2019).

Second Driver: Limited Institutional capacity to respond to shocks
The rating agency’s last two rating actions (December 2015 and December 2016) which affirmed the rating were based on the expectation of a policy response in the form of sustainable fiscal consolidation that would rely on reducing the deficit through expenditure cuts and changing the structure of outlays. In the last two fiscal years, the country posted deficits that were sharply above the government’s original targets due to the absence of effective fiscal consolidation. The deficit reduction in the current budget relies mostly on SACU revenue increases and hence is unlikely to be sustainable. Moreover, by raising the already high share of recurrent spending, especially wages, at the expense of infrastructure, the current budget will hinder medium-term growth and hence domestic revenues. The lack of an effective policy response has led Moody’s to lower its assessment of the country’s institutional strength, one of the four major rating factors under its sovereign bond methodology.

In Moody’s view, the vulnerability to shocks has recently risen and the fiscal space for policy maneuver was further eroded with a sizeable increase in the wage bill, which already amounted to 40% of total expenditures in the 2016/17 fiscal year, to a projected 45% in the 2017/18 fiscal year. This is also reflected by an elevated fiscal spending in the 2017/18 budget to 40% of GDP, up from 35% budgeted in the mid-term budget review in October 2016. Even before this latest wage increase, Namibia had one of the highest wage bills (according to various metrics) in Africa and among middle income countries globally. Only limited structural changes have been made on the revenue side, with highly volatile SACU revenues are still projected to amount to more than one third in 2017/18. These moves have reinforced the existing fiscal rigidities and further eroded the government’s fiscal space to respond to future negative shocks.

Stabilization of the debt trajectory hinges on some fiscal consolidation and is vulnerable to lower-than-expected real GDP growth and other shocks. In particular, if no fiscal consolidation is implemented, the debt-to-GDP ratio could cross 60% in 2020. A similar deterioration in debt trajectory could be generated by a combination of interest rate and exchange rate shock.

Third driver: Risk of renewed government liquidity pressure
The liquidity tensions were among the key drivers of the negative outlook assigned in December 2016, and the revelation of off-balance sheet arrears to the private sector in July 2017 shows another dimension to the liquidity pressures. Since then the government’s exposure to the risk of tighter domestic funding conditions has declined because of a combination of a loan provided by the African Development Bank (Aaa stable), improved inflation/exchange rate (rand) expectations and improved revenues. However, from a rating perspective, preventing further and potentially more pronounced liquidity pressures in the coming years hinges on credible fiscal consolidation.

More specifically, the emergence of unbudgeted arrears to the private sector, amounting to about 1 – 1.5% of GDP (on top of 1% of GDP budgeted arrears) has been putting pressure on the banking sector by directly or indirectly impeding the ability of private sector borrowers to service their debt. The banking sector remains a key source of government funding. Moody’s noted that the government has secured a loan from the African Development Bank, which has eased any imminent funding issues. However, the liquidity pressures observed in the 3rd quarter of 2016 could re-emerge with waning banking sector appetite, especially if the government were to address shortfall in revenues through resorting to ‘arrears financing’ for some of its outlays. Such a development in the absence of credible fiscal consolidation efforts could also affect the country’s access to other sources of funding.

Drivers of Negative Outlook
Risks are still tilted to the downside, with key risks including the possibility of lower than projected SACU revenues, an exchange rate shock, a shock to commodity prices, change of investor sentiment/sudden stop of capital flows as well as an interest rate shock. In the run up to the South West African People’s Organization (SWAPO) leadership elections (Dec 2017) and presidential elections (2019), political risk has also increased. These risks are only partially counterbalanced by better prospects for higher growth and a gradual rise in domestic revenues on the back of more favourable domestic economic conditions supported by the ongoing global recovery.

Factor that could stabilize the outlook
While an upgrade in the near term is unlikely, we would stabilize the outlook on Namibia’s rating if the government demonstrated commitment to fiscal consolidation that would result in a marked slowdown and eventual reversal of debt accumulation. A structural improvement in the twin balances, a sustained easing of funding conditions in the domestic market and a permanent increase in foreign exchange reserves would be also positive.

Factors that could lead to a downgrade
We would likely downgrade Namibia’s rating further if the fiscal consolidation plan were ineffective in containing the rapid public sector debt accumulation beyond our baseline scenario. A sustained decline in foreign currency reserves to below three months of import cover and/or an increase in funding pressure resulting from reduced market appetite for government securities that lead to a material increase in borrowing costs would also put downward pressure on the rating.