Moody’s places Tunisia’s B2 rating on review for downgrade

TUNIS (Capital Markets in Africa) — Moody’s Investors Service (“Moody’s”) has today placed the Government of Tunisia’s B2 issuer ratings on review for downgrade.

Moody’s has also placed the Central Bank of Tunisia’s B2 senior unsecured rating and the (P)B2 senior unsecured MTN program and senior unsecured shelf ratings on review for downgrade. The Central Bank of Tunisia is legally responsible for the payments on all of the government’s bonds. These debt instruments are issued on behalf of the government.

The decision to place the ratings on review for downgrade reflects the acute tightening in global financing conditions that risks precipitating a sustained period of high financing risk, exacerbated further by Tunisia’s weakened near-term economic growth prospects, deteriorating fiscal position, and fragile external position.

The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions, and markets. The combined credit effects of these developments are unprecedented. Moody’s regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.

For Tunisia, the shock transmits mainly through wider risk premia, a drop in tourism revenue, and a sharp slowdown in GDP growth that weaken the sovereign’s liquidity and external position and raise its debt burden. The shock increases the risks to Tunisia’s credit profile significantly compared to increasing confidence that macroeconomic stability would be sustained at the time of Moody’s change in the outlook on Tunisia’s ratings to stable from negative last February.

The review period, which may extend beyond the usual three-month horizon, will focus on assessing the authorities’ capacity to manage such a significant shock in the context of existing economic, financial and social pressures, and evaluating the options to address the resulting fiscal and external funding gap.

Tunisia’s local currency and foreign currency long-term bond and deposit ceilings remain unchanged: the long-term local currency bond and bank deposit ceilings at Ba2, long-term foreign currency bank deposit ceiling at B3, and the foreign currency bond ceiling at Ba3. The short-term foreign-currency bond and bank deposit ceilings remain unchanged at Not Prime.

Increased financing risks
Elevated credit spreads increase financing risks for Tunisia in view of the government’s significant funding needs every year over the next few years and in light of a limited FX reserve buffer, with a rigid budget spending structure and challenging social conditions suggesting minimal scope to enact wide-ranging adjustment to reduce the fiscal and external financing gap.

Yields on outstanding Tunisian instruments have risen to over 900 basis points (bp) (compared to about 500 bp at the time of the February rating action where Moody’s changed the outlook on the B2 rating to stable from negative), indicating impaired market access at this point. In comparison with peers, Tunisia’s immediate exposure to refinancing risk is relatively high with the government’s international bond maturities due this year amounting to 10% of reserves. These financing needs continue over the next several years, with low reserves coverage of economy-wide external debt payments.

The government relies to a large degree on external official funding sources to meet its gross financing needs at about 10-15% of GDP. While negotiations for a follow-up IMF program are underway after the cancellation of the remainder of the previous four-year Extended Fund Facility that started in May 2016, the government has secured a $745 million disbursement under the IMF’s Rapid Financing Instrument (RFI) and a $280 million loan from the Islamic Development Bank (Aaa stable) to address the additional fiscal costs of its coronavirus response program.

However, wider fiscal and current account deficits than previously expected due to marked shortfalls in government revenue risks raising Tunisia’s financing needs beyond what has been secured so far at a time when financing options are constrained. In particular, a weak banking system limits the capacity for the government to tap domestic sources of funding over an extended period.

The review period will focus on the government’s adjustment capacity in the context of such a significant shock that aggravates existing economic, financial and social pressures, including progress in negotiating a new funded IMF program that may provide a backstop to immediate financing requirements.

Coronavirus shock delays fiscal consolidation progress and pushes debts toward 80% of GDP
The government’s coronavirus response program of about $1 billion (2.7% of estimated 2020 GDP), combined with a revenue shortfall, drives Moody’s projected fiscal deficit to more than 5% of GDP in 2020 from 3.5% in 2019 and against a previously anticipated improvement to 3% at the time of the February rating action. Combined with slower nominal GDP growth, the debt ratio will increase towards 80% of GDP against Moody’s previous expectation of stabilization at below 75%. The debt trajectory will be highly dependent on exchange rate developments at a time of increased pressure on emerging market currencies. So far, Moody’s assumes broad stability in the Tunisian dinar.

Among the announced measures, the government will raise health spending, strengthen social safety nets, and support small- and medium-sized firms via tax relief measures and interest subsidies—all of which will weigh on the budget deficit.

Moreover, the president ordered a general lockdown until April 19, limiting citizens’ free movement in an effort to curb the spread of the coronavirus, which will weigh on economic activity and government revenues, further aggravating the budget deficit and debt burden.

Long-delayed reforms of state-owned enterprises (SOEs) that carry a government guarantee and account for about 16% of GDP add to the risk of contingent liabilities materializing on the government’s balance sheet.

The review will assess the government’s capacity to arrest a rising debt trend, depending on exchange rate movements and the potential materialization of contingent liabilities.

Sharp decline in tourism weigh on growth prospects, external accounts, raising social risks
The tourism industry in Tunisia contributes about 10% of GDP and accounts for a similar share of employment. The restoration of the tourism industry over the past five years has been key in creating new employment, in driving services activity and in generating foreign exchange reserves. A prolonged slump would not only weigh on Tunisia’s growth outlook but risk jeopardizing social stability in light of persistently weak employment.

Moody’s anticipates a sharp economic contraction in 2020, followed by a recovery in 2021, assuming global growth and travel return, and a reversion to a trend growth rate of 1.5-3% in future years. Under this scenario, the level of economic activity will be markedly below what could have been expected before the shock for years to come. Rigid labor markets mean productivity will be constrained, while limited employment prospects, especially for young graduates, increase the risk of social discontent in the future.

Risks to these projections are on the downside. In particular, the tourism sector may take longer than other sectors of the global economy to recover from the coronavirus shock, further constraining employment prospects, and reducing a key contributor to FX generation.

The review period will allow Moody’s to assess the depth, duration, and spillover effects of the domestic and global shock, and potential implications for potential growth and social stability.

Environmental, social and governance considerations
Environmental considerations are relevant for Tunisia’s credit profile because the effects of climate change can significantly impair economic growth and development. Coastal regions account for 80% of total output, the majority of which are exposed to rising sea levels. Climate variability, erratic precipitation patterns, and severe droughts pose significant threats to Tunisia’s agricultural sector, which accounts for more than 15% of total employment.

Social considerations are material for Tunisia’s credit profile. In recent years, social tensions have increased in response to fiscal adjustments made under the current program with the IMF and in response to persistently slow growth and employment trends. The threat of social unrest can impact the capacity of the government to implement necessary reforms. Moody’s views the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. For Tunisia, the shock materializes primarily through a sharp tightening in financing conditions and a drop in tourism revenue and growth.

Governance considerations are material for Tunisia’s credit profile and relate to the administration’s demonstrated capacity to function even during times of social unrest. The country’s consensus-building governance orientation has been instrumental in securing the successful democratic transition with all stakeholders involved, but it can slow down the policy decision making process.

Factors that could result in confirmation of the current rating 
The rating would likely be confirmed at the current B2 level if the review concluded with sufficient confidence that the coronavirus shock will not materially alter Tunisia’s debt trajectory and/or erode the recently restored foreign exchange reserve buffer. Similarly, high confidence in Tunisia’s ability to secure funding to meet its upcoming debt service payments in the next few years at affordable costs could also support the confirmation of the rating at the current level.

Factors that could lead to a downgrade
Conversely, a downgrade would be likely if there were delays in the availability of or marked increase in the cost of external funding or a significantly more severe deterioration in Tunisia’s fiscal and debt metrics that would weaken Tunisia’s fiscal strength and foreign exchange reserves adequacy.

Evidence that the coronavirus shock would reduce potential growth, thereby exacerbating social tensions and lower the prospect for fiscal consolidation could also result in a downgrade.