Fitch Ratings has affirmed Mozambique's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'RD' (Restricted Default). There is no Outlook on the IDR.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The affirmation reflects the sovereign's failure to cure the default on debt to external commercial creditors. Since Fitch downgraded Mozambique to 'RD' in November 2016, the sovereign has missed four coupon payments on its sole Eurobond, as well as principal and interest payments on government-guaranteed loans to state-owned companies Proindicus and Mozambique Asset Management (MAM).
Fitch does not anticipate a near-term resolution to the default. Key differences remain between bondholders and the government regarding the terms of a debt restructuring, including the treatment of different classes of defaulted debt (Eurobond vs SOE government-guaranteed loans). In March, the government presented restructuring guidelines, including haircuts on past-due interest, lengthening of maturities and lower coupon payments, as well as reiterating the official position that that both Eurobond and guaranteed loans will be subject to restructuring. In June, the authorities followed up with official projections reflecting that revenues derived from natural gas projects will only increase materially around 10 years after the projected start of production in 2022-23. A group of bondholders has reportedly submitted a restructuring proposal tied to gas revenues and that would not include haircuts.
Inflationary pressures remain subdued. Fitch expects inflation to average 4.6% in 2018, significantly down from 15.1% in 2017, and 6.8% and 8.0% in 2019 and 2020, respectively, reflecting a tight monetary policy stance, limited depreciation pressures and weak domestic demand pressures. The BdM has cut its policy rate (MIMO) by 450bp to 15% in 2018. Further easing is likely to take into account the evolution of public finances, the speed of domestic demand recovery and external factors impacting foreign currency inflows such as commodity prices and growth in trading partners.
Growth will remain below the historical trend. Fitch forecasts growth of 3.5%, compared with 3.7% in 2017, but this still reflects an underlying recovery, as coal output increases in 2017 contributed almost 1pp to growth. Growth will improve slightly to 3.7% in 2019 and 3.8% in 2020 in the context of continued external financing constraints and uncertainty about the resolution of the dispute with creditors. However, growth will pick up significantly in 2022-2023 when the natural gas mega-projects are scheduled to start production.
The financial sector has stabilised, but remains vulnerable given the weak recovery prospects and large exposure to the public sector. After rising to 12.6% in 2017, NPLs have stabilised and reached 12.8% in June 2018 reflecting weakened SOE balance sheets, exposure to Proindicus, public sector supplier arrears and difficult financing and demand conditions for private sector companies. After contracting by 13% in 2017, credit will remain constrained by limited demand, a deteriorating portfolio and still high costs. The central bank has increased foreign currency reserve requirements to prevent foreign currency credit growth.
Fiscal pressures remain present given limited room for further expenditure cuts, risks to revenue performance from lower-than-anticipated growth, a rapidly rising interest bill and an unsustainable debt burden. Fitch expects the deficit to reach 5.7% of GDP on a cash basis in 2018 (6.9% including interest arrears), up from 3% in 2017 when Mozambique benefited from a one-off capital gains tax of 2.8% of GDP. The fiscal deficit will then increase gradually by 6.1% and 6.7% of GDP in 2019 and 2020 (7.3% and 7.8% including interest arrears), respectively, reflecting still weak growth compared with the historical trend and expenditure pressures due to elections in 2018 and 2019 electoral cycle and the implementation decentralisation in 2020. Material revenues from natural gas projects are not expected until 2032, according to government estimates
Government debt (including guarantees) is forecast to increase to 102% in 2018. This debt metric includes commercial debt in default and external guaranteed debt. The debt trajectory is highly sensitive to exchange rate volatility given the high share of foreign currency debt. The current level of domestic arrears remains unclear after reaching 3.7% of GDP at end-2016.
After narrowing to 20% of GDP in 2017 reflecting export increases, weak imports and the transfer of the capital gains tax (USD325 million), Fitch expects the current account deficit to increase to 23% of GDP in 2018. The investment and construction phase of the upcoming mega projects will lead to a higher current account deficit in 2019-2020, but this will be financed by FDI related to these projects. International reserves equalled USD3156 million (3.7 months of CXP) in August, down by USD142 million since end-2017, mostly reflecting debt repayments. Mozambique's external liquidity ratio (forecast at 97% in 2019) remains weak given high commodity dependence and restricted access to external financing.
Mozambique's structural profile is significantly weaker than peers in terms of GDP per capita, institutional strength and transparency, business environment and human development indicators. On the other hand, the country has a long track record of receiving multilateral and bilateral technical support and financial assistance (on a concessional basis), although budget support has been curtailed since 2016. Its large natural resources endowment continues to attract investment that will boost growth, export and government revenues in the long term.
Municipal elections are scheduled for October 2018 and national elections are expected to take place a year later. Despite the death of RENAMO's leader, the ruling party FRELIMO is making progress towards finalising a peace agreement based on greater decentralisation and the integration of RENAMO fighters into the security forces. Changes to the constitution have already been approved to allow for greater decentralisation.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
In line with Fitch's published criteria and reflecting the fact that Mozambique remains in default on its commercial debt obligations, the sovereign rating committee has not utilised the SRM output and has maintained the Long-Term Foreign-Currency IDR at 'RD'.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year-centred averages, including one year of forecasts, to produce a score equivalent to a LTFC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
RATING SENSITIVITIES
The curing of the default, such as through a debt restructuring leading to a normalisation of relations with creditors would lead to an upgrade of the Long-Term Foreign-Currency IDR. At that time, Fitch would review Mozambique's ratings and upgrade the ratings to a level consistent with the sovereign's ability and willingness to service debt, as well as its economic fundamentals.
KEY ASSUMPTIONS
Fitch assumes that broad political stability will be maintained given progress towards a peace process between the government and RENAMO.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR affirmed at 'RD'
Long-Term Local-Currency IDR affirmed at 'CC'
Short-Term Foreign-Currency IDR affirmed at 'C'
Short-Term Local-Currency IDR affirmed at 'C'
Country Ceiling affirmed at 'B-'
