Fitch Affirms Mozambique at ‘B’

Fitch Ratings has affirmed Mozambique’s long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘B’, its Short-term foreign currency IDR at ‘B’ and its Country Ceiling at ‘B’ and removed them from Rating Watch Negative (RWN). The Rating Outlook is Negative. Under EU credit rating agency (CRA) regulation, the publication of sovereign reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations. Fitch interprets this provision as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that Fitch believes makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status. The next scheduled review date for Fitch’s sovereign rating on Mozambique is 29 April 2016, but Fitch believes that developments in Mozambique warrant such a deviation from the calendar and the rationale for this is laid out below.

The removal of all ratings from RWN and the Negative Outlook on Mozambique’s reflect the following key rating drivers and their relative weights: HIGH The removal of the RWN follows the announcement on 17 March of the final terms of the debt exchange to holders of outstanding bonds issued by state-owned Empresa Mocambicana de Atum (EMATUM). The offer seeks to exchange USD697m in outstanding government- guaranteed liabilities (6.305% coupon, twice yearly amortising and 2020 maturity date) for a 10.5% coupon, back-loaded bullet sovereign bond maturing in 2023. Bondholders have until 29 March to agree to the offer. Under Fitch’s Distressed Debt Exchange (DDE) criteria, the final exchange offer does not constitute a DDE. Although there is potentially a material reduction in terms compared with the original contractual terms, primarily because of the maturity extension, the agency does not consider the exchange to be necessary to avoid a traditional payment default on the guaranteed EMATUM bond. Both criteria would need to apply in order for the debt restructuring to be classified as a DDE under our criteria. Although Mozambique’s credit profile has weakened over the past year, Fitch believes that the country would have the capacity and willingness to continue servicing the outstanding EMATUM liabilities. Even as external debt servicing costs have doubled in nominal terms since the start of EMATUM repayments in September 2015, Mozambique has maintained fairly low debt-servicing commitments, reflecting the still highly concessional nature of the debt stock (around 70% of total debt). According to Fitch’s calculations, total public debt service reached 2.6% of GDP in 2015, versus 5.3% for the ‘B’ median. Similarly, interest payments accounted for only 4.8% of revenue in 2015, compared with 15.4% in Zambia and 30.6% in Ghana. Importantly, the IMF continues to judge the risk of debt distress as moderate, in spite of the 33% depreciation of the exchange rate in the past year (85% of total public debt is external and denominated in foreign currency) and the sharp fall in foreign reserves (from USD3bn at end-2014 to USD1.84bn in mid-March 2016). Moreover, the authorities’ decision to seek an 18-month standby credit facility (SCF) with the IMF in December 2015 highlights a commitment to policy reform, including ongoing fiscal consolidation, improvements in debt management, monetary policy adjustment and structural reforms. This should help to procure ongoing multilateral and bilateral debt, in turn, lessening the risks of a fiscal and/or balance of payments crisis.

The assignment of the Negative Outlook highlights the deterioration in key credit metrics since our last full review in November 2015, in particular in terms of rising public debt levels and a weaker external position.   Fitch now estimates gross general government debt (GGGD) at 73% of GDP in 2015, compared with 61% in our previous review and a 16.4pp increase from 2014, in large part as a result of the depreciation of the metical. Further currency weakness is likely to push the GGGD/GDP ratio to over 80% this year, despite a projected narrowing in the fiscal deficit. This compares with a B median average of 52%. Any delays in fiscal consolidation would constitute downside risks to our forecast. The fall in commodity prices has taken a toll on Mozambique’s external finances, primarily via lower capital inflows. Foreign direct investment flows for gas, mining and other resource extraction sectors have traditionally been the main source of funding for the very large current account deficit, but net foreign direct investments (FDI) fell by close to 10pp in 2015, to an estimated 19.5% of GDP. Even as the current account deficit is expected to shrink in the short-term (reflecting import compression in both goods and services and a weaker exchange rate), a worsening investment outlook will maintain pressure on FX reserves in 2016. Fitch forecasts FX reserves coverage (in terms of current account payments) to fall to 2.7 months this year, below the ‘B’ median of 3.6 months.

Mozambique’s ratings will be formally reviewed again on 29 April 2016, in line with Fitch’s published calendar. The review will consider the following factors that could lead to a downgrade: – Worsening public and external debt dynamics. -Deterioration in the level and/or expected trajectory of foreign exchange reserve coverage. -Commodity price changes that jeopardise the development of the LNG sector and erode external debt sustainability. The following factors could lead to the Outlook being revised to Stable: – Fiscal consolidation leading to a decline in government debt/GDP. -Improved investor confidence in the development of natural resource sectors leading to a stronger external position. -Effectively tackling structural weaknesses, including improving the business environment and providing stable growth to lift income per capita.

Fitch assumes that the debt exchange offer will go ahead as proposed. Fitch assumes Brent oil prices to average USD35/bl in 2016 and USD45/bl by 2017.