Rwanda Upgraded To ‘B+’ On Diminishing External Financing Risks; Outlook Stable

Overview
• Risks to Rwanda’s external financing are reducing owing to stable donor flows and the government’s ability to access the capital markets.
• Real GDP growth rates have rebounded to more than 6.0% in 2014 from the 2013 low of 4.6%, and we project 7% GDP growth for Rwanda in 2015-2018. Fiscal consolidation is on track, and deficits are narrowing.
• We are raising our long-term ratings on Rwanda to ‘B+’ from ‘B’ and affirming the ‘B’ short-term ratings.
• The stable outlook reflects our view that stability of external funding will support Rwanda’s external position, while its fiscal position will not significantly deteriorate from our current forecasts. We also think that the upcoming presidential succession in 2017 will be well managed.

Rating Action
On March 13, 2015, Standard & Poor’s Ratings Services raised its long-term foreign and local currency sovereign credit ratings on the Republic of Rwanda to ‘B+’ from ‘B’ and affirmed its ‘B’ short-term foreign and local currency sovereign credit ratings. The outlook is stable.

Rationale
We consider that Rwanda’s external position is improving because we perceive risks from external shocks–namely reliance on donor support, or the refinancing the growing stock of government external debt–have diminished. When donor funding was suspended in November 2012, the Rwandan economy, which relies on external financing for its twin deficits, faced a turbulent 2013 with a slowdown in economic growth and fiscal expenditure adjustments. Since then, Rwanda successfully issued a US$400 million Eurobond, and donor funding has resumed and been stable over the past two years.

We expect the current account deficit to average 9.5% over 2015-2018, while import pressures remain high amid slow growth in exports in the short term. Consequently, we forecast gross external financing needs as a percentage of current account receipts (CARs) and usable reserves slightly above 100% in 2015-2018. Rwanda’s external liabilities are dominated by external debt, which makes up two-thirds of the total, while foreign direct investment (FDI) represents the remaining third. We estimate external debt, net of liquid external assets, will average more than 50% of CARs in 2015-2018.

The Rwandan economy has bounced back sharply since posting real GDP growth of 4.6% in 2013. We estimate real GDP growth at 6.3% in 2014 and at least 7% on average over 2015-2018. We think that the stability in external financing and continued government investment spending will support higher economic growth rates in the next few years. Government activity–both consumption and investment–is the largest contribution to GDP, while the private sector is still small but growing.

We estimate GDP per capita at US$730 in 2015. Over the 10-year period from 2008 to 2017, we estimate the weighted annual average of real GDP per capita growth at 3.7%, which lags faster-growing peers Mozambique (5.2%) and Ethiopia (6.3%).

We consider that Rwanda’s fiscal consolidation path is on target after donor support stabilization and the near completion of financing of capital expenditures via the Eurobond issue. We forecast general government deficits will average 3% of GDP over 2015-2018. We also think that the change in general government debt will average 3% of GDP over the same period, compared with 4.5% over 2011-2014. Under the new International Monetary Fund policy support instrument agreement, Rwanda is aiming to reduce donor reliance and increase the ratio of domestic tax revenues to GDP. The government has earmarked various measures, including reviewing some value-added tax exemptions, taxes on mining activity, and the collection of property taxes at the central government level. We think it may achieve these measures over the medium- to long-term.

Relative to peer benchmarks, Rwanda has low general government debt, with gross levels we estimate at 30% of GDP in 2015-2018. We estimate net general government debt will average 25% over the same period.

Donor support was suspended in late 2012 due to alleged Rwandan involvement in supporting the M23 rebel group in the Eastern part of the Democratic Republic of Congo (DRC). Although Rwanda’s relations with DRC remain tense, immediate geopolitical instability in Eastern DRC dissipated following the DRC army’s defeat of M23 rebels with the help of U.N. support. In addition, Rwanda has received support from the international community–through the U.N.–in the calling for disarmament of the Forces Démocratiques De Libération du Rwanda (FDLR) rebel group composed of ethnic Hutus, accused of perpetrating the 1994 genocide, and also based in Eastern DRC. In the future, we think that donor support for Rwanda is less vulnerable because donors have switched their provision of support to specific sectors and projects from general government budget support. Donors generally view Rwanda as one of the most effective and transparent recipients of aid.

Rwanda’s central bank maintains a flexible exchange-rate regime, with occasional interventions to smooth volatility. We believe inflation trends in the coming few years will remain close to the central bank’s target of 5% because stable fuel prices and higher agricultural production will result in broadly steady food prices. Private-sector credit growth is normalizing at about 15%, after rapid growth topping 30% in 2012 that then dropped to 10% in 2013.

The banking system in Rwanda is adequately capitalized, in our view. Although some smaller banks’ profitability is weak, the banking sector is small relative to the economy, with total system assets amounting to less than 30% of GDP and therefore representing low contingent liabilities for the sovereign.

In Rwanda, political power remains concentrated under the leadership of President Paul Kagame, with limited checks and balances. The Rwanda Patriotic Front (RPF) continues to dominate the political landscape as it has done since the end of the civil war in 1994. The party and, more generally, Rwanda, now face the challenge of President Kagame’s succession.

President Kagame will reach the end of his seven-year second term in 2017 and is required to step down under the current constitution. At this stage, however, it is unclear whether President Kagame and his RPF party will propose amending the constitution to extend his term in office. We think the decision will likely be delayed until closer to the scheduled elections in 2017. Our current ‘B+’ rating and stable outlook incorporate our view that the 2017 transition will likely be in line with the current constitution and not weaken the country’s institutional framework.

The ratings on Rwanda are constrained by its low per capita GDP and its significant reliance on external funding. The ratings are supported by low general government debt relative to peers’, and our anticipation of only modest deficits in the next few years.

Outlook
The stable outlook reflects our view that stability of external funding will support Rwanda’s external position over a one-year horizon, while the fiscal position will not significantly deteriorate from our current forecasts. We also think that President Kagame’s upcoming presidential succession in 2017 will be well managed.

A positive rating action within the next year appears remote at this stage.

We could consider a negative rating action if Rwanda’s external and fiscal deficits were to deteriorate more than we currently assume. An expansionary fiscal stance, financed externally for example, would not be compatible with Rwanda’s current rating level given its other rating characteristics.

Similarly, we could consider lowering the ratings if Rwanda’s succession risks rose, affecting government institutions and the country’s general functioning.

Source: Standard and Poor’s Ratings