Moody’s downgrades Tunisia’s rating to B1, maintains negative outlook

TUNIS (Capital Markets in Africa) – Moody’s Investors Service has today downgraded the long-term issuer rating of the government of Tunisia to B1 from Ba3 and maintained the negative outlook. Moody’s has also downgraded the foreign currency debt rating of the Central Bank of Tunisia to B1 from Ba3 and maintained the negative outlook, in addition to downgrading the shelf/MTN rating to (P)B1 from (P)Ba3. The Government of Tunisia is legally responsible for the payments on all of the central bank’s bonds. These debt instruments are issued on behalf of the government.

The key drivers for the downgrade to B1 are:

1) Continued structural deterioration in Tunisia’s fiscal strength;
2) Persistent external imbalances;
3) Reduced institutional strength and government effectiveness as highlighted by the track record of delays in the agreed reform implementation program with the IMF.

The negative outlook reflects the risk of a more sustained than anticipated decline in foreign exchange reserves with concomitant depreciation pressures which could fuel adverse public debt dynamics. It also takes into account Tunisia’s increasing funding requirements in view of upcoming international bond redemptions starting 2019 amid reduced visibility about access to external funding sources, in addition to rising contingent liability exposures to the public banking sector, to the pension system and with respect to state-owned enterprises (SOEs).

As part of today’s rating action, Tunisia’s long-term local currency bond and bank deposit ceilings were lowered to Ba1 from Baa2. The long-term foreign currency bank deposit ceiling was lowered to B2 from B1, and the foreign currency bond ceiling to Ba2 from Ba1. The short-term foreign currency bond and bank deposit ceilings remain unchanged at NP.

Ratings Rationale
First Driver for the downgrade: Continued Structural deterioration in Tunisia’ Fiscal Strength. Tunisia’s fiscal performance has continued to deteriorate since the last rating action in November 2016 in response to higher than anticipated spending pressures and a heavy public sector wage bill amounting to over 14% of GDP, or about 60% of total revenues, which underpins the budget’s structural rigidity. Wages, interest payments and transfers/subsidies accounted for 93% of total revenues and grants at the end of 2016, thus leaving limited room for expenditure adjustment in case of slower than anticipated growth and revenue collection. Under the current multi-year wage agreement between the government and the main labor union, the public sector wage share is expected to decline to 12% of GDP by 2020. In our central scenario, we expect the fiscal cash balance to remain unchanged at 6.1% of GDP in 2017 before declining to 5.4% in 2018.

The higher than anticipated primary deficit in 2016, slower growth and adverse exchange rate movements have combined to drive the debt/GDP to 61.9% of GDP at the end of 2016 from 50.8% in 2014. We expect the debt/GDP ratio to exceed 70% of GDP in 2018 and to peak at 72.4% of GDP in 2020, entailing a further decline in fiscal strength. The debt trajectory remains particularly vulnerable to adverse exchange rate dynamics due to the high foreign-currency share at over 65% of total central government debt.

Second Driver for the downgrade: Persistent External Imbalances: Current account dynamics have continued to deteriorate over the first half of 2017 after assignment of the negative outlook in November 2016 due to structural declines in energy and phosphate balances which partially offset improved mechanic and electric exports. While the tourism sector has recorded a rebound from low levels, higher tourist arrival numbers will take time to translate into higher current account receipts due to the low value added offering and high share of intra-regional travel. We expect the current account balance to remain elevated at 9.8% of GDP in 2017, followed by 8.7% in 2018 amid subdued foreign direct investment inflows.

The continued decline of foreign exchange reserves to 90 days of import cover as of August 2017 in conjunction with the high gross external funding requirements at about 25% of GDP per year over the next few years underpin Tunisia’s high external vulnerability assessment. At over 70% of GDP at the end of 2016, Tunisia’s external debt ratio is at the higher end among Moody’s B and Ba-rated credits, as is the net international investment position at a negative 116% of GDP as of 2016.

Third driver for the downgrade: Reduced Institutional Strength as result of delayed reform implementation. While Tunisia’s consensus-based policy making process has ensured the successful political transition with the adoption of the new constitution in January 2014, the track record of recurring delays in IMF reform program implementation resulting in disbursement postponements from official lenders points to a decline in government effectiveness and reduces the visibility of medium-term funding access, even as the funding requirements over the next twelve months have been secured.

The stabilization of the public sector wage bill, the implementation of energy subsidy reform and progress with the state-owned bank restructuring process are among the IMF’s long-standing key requirements on which progress has been achieved before the conclusion of the first review in June 2017. The timeline for the planned parametric pension reform, the restructuring of SOEs and for tax reform is challenged by the local elections planned for December 2017.

Rationale for the B1 Rating
The B1 rating is supported by the nascent economic recovery driven by the mining, tourism and agricultural sectors, and underpinned by fewer instances of social unrest in internal regions. In our central scenario we expect annual growth at 2.3% in 2017, followed by 2.8% in 2018. The significant improvement in the security environment in the aftermath of the 2015 terror attacks sets the stage for renewed investment activity in the wake of the “Tunisia 2020 Investor Conference” held in November 2016 and of Tunisia’s participation in the “G20 Compact with Africa” initiative launched in March 2017 to promote private investment in participating countries. The government’s recently intensified fight on corruption also addresses one of the most problematic factors for doing business cited in executive opinion surveys and which impacts the country’s competitiveness assessment.

Rationale for the negative outlook
The negative outlook reflects the risk of renewed fiscal overruns and of a more sustained than anticipated decline in foreign exchange reserves with concomitant depreciation pressures which could fuel adverse public debt dynamics. It also takes into account Tunisia’s increasing funding requirements in view of upcoming international bond redemptions starting 2019 amid reduced visibility about access to external funding sources. Rising exposures to contingent liabilities among state-owned banks, in the pension system and with respect to financially challenged state-owned enterprises (SOEs) with guaranteed debts amounting to 12% of GDP that are not included in the central government debt ratio add to the negative risk balance.

Factors that could stabilize the outlook
A sustained economic recovery, supported by reduced social unrest, in addition to the stabilization and reversal of fiscal and external imbalances with improved funding visibility could return the outlook to stable. A track record of previously agreed reform implementation would also be credit positive.

Factors that could lead to a downgrade
Renewed fiscal overruns, a continued erosion of foreign exchange reserves or the materialization of contingent liabilities represent downside risks. A weaker than expected economic recovery and further delays with the implementation of the economic reform program agreed with the IMF that would lead to reduced access to official funding sources and deter market appetite, could also lead to a downgrade.