Fitch affirms Mozambique at ‘CCC’

The ‘CCC’ rating reflects continuing high fiscal and external financing needs, exacerbated by the coronavirus shock and the two cyclones that hit Mozambique in 2019. Financing pressures are compounded by high general government (GG) debt and ongoing unresolved public-sector debt liabilities.

The pandemic comes as Mozambique was recovering from the destruction of crops and infrastructure following last year’s devastating cyclones. We forecast GDP growth to decelerate to 2% in 2020, down from our pre-virus forecast of 5% and an estimate of 2.2% in 2019. Economic disruptions related to virus-containment measures, coupled with lower prices and demand for Mozambique’s commodity exports, will partially offset the economic benefits of a recovery in the agricultural and construction sectors. We expect growth to rebound to 4.3% in 2021 and 4% in 2022.

The hit to tax revenues along with spending pressures from the pandemic shock and post-cyclone reconstruction needs will cause the fiscal deficit on a cash basis to widen to 5.8% of GDP in 2020 (12% of GDP excluding grants) from a 0.2% surplus in 2019. The 2019 figure would have registered a deficit of 5.6% had it not been for one-off tax revenues related to the sale of Occidental Petroleum Corp.’s liquefied natural gas (LNG) operations to Total. We project the fiscal deficit to narrow to 4% of GDP in 2021 and 3.4% in 2022 as pandemic spending winds down and growth rebounds. The projections assume grants worth 4.5% of GDP per year on average.

Funding options remain narrow. Some official creditors have resumed budget-support flows, which had stopped in 2016, to finance emergency spending associated with the post-cyclone reconstruction needs and the pandemic. Their commitment to expanded forms of direct budget funding remains uncertain in Fitch’s view. Moreover, the government is likely to have difficulty in accessing international capital markets, given the current global environment and its recent history of default. The shallowness of the local-currency bond market also constrains domestic financing flexibility.

We expect the government to meet its full-year 2020 financing needs (12% of GDP) through a mix of official creditor funding (5% of GDP) that includes the IMF’s emergency financing, domestic bond issuance (3.6% of GDP) and likely participation in the Debt Service Suspension Initiative (DSSI) which would alleviate financing needs by 1.4% of GDP. We assume the government will close the remaining financing gap by drawing down on its deposits.

The government is discussing possible debt restructuring beyond the DSSI with some official bilateral creditors. Fitch understands that the authorities are committed to excluding market debt in the sovereign’s debt restructuring and relief negotiations. A medium-term programme with the IMF could ease financing conditions over the projection horizon. Discussions initiated by the authorities with the IMF have reportedly been delayed due to the pandemic, but could resume in 2H20.

The status of two loans to the State-Owned-Enterprises (SOEs) Proindicus and MAM with purported state-guarantees remains uncertain. Since 2016, the SOEs have not made principal or interest payments on their respective loans, which totalled USD2.1 billion (14% of GDP) including arrears in 2019. The government is challenging the validity of both guarantees in the context of the ongoing legal disputes in the English courts. The uncertainty surrounding these obligations and the ongoing judicial proceedings means that at this stage Fitch cannot deem the sovereign guarantees to be unequivocal, irrevocable and unconditional, and the missed payments therefore do not currently constitute a default under our criteria.

We project GG debt to rise to 106% of GDP in 2020 from 97% of GDP in 2019, due to high financing needs, the metical’s depreciation (86% of GG debt is denominated in foreign currency), and the accumulation of external arrears. Our debt estimates include the liabilities of Proindicus and MAM, but otherwise exclude guaranteed domestic debt. We forecast GG debt to then decline to 104% of GDP in 2021 and 96% in 2022.

The coming on stream of LNG megaprojects (total investments worth around 395% of 2020 GDP) initially planned for 2023-2024 could have a positive impact on medium-term growth prospects. Exxon Mobil postponed its final investment decision of USD30 billion (197% of 2020 GDP) to 2021, which will delay the start of production to at least 2026. However, production related to projects operated by Total and Eni is still planned to commence around 2023-2024.

We project the current account deficit (CAD) to deteriorate to an exceptionally high 64% of GDP in 2020 from 21% in 2019, due to a higher LNG megaprojects imports, depressed coal exports and higher imports of goods for healthcare and reconstruction. Private loans and FDI related to the megaprojects, coupled with government and bank borrowing, will cover 86% of external financing needs, while we assume Mozambique will draw on its international reserves, worth USD4 billion at end-April 2020 (4.7 months of current account payments). We forecast the CAD to widen to 68% in 2021 and 80% and 2022 as the megaproject flows intensify.

The metical depreciated by 14% against the US dollar in the first half of 2020, and we expect some modest further depreciation during the rest of the year. We expect inflation to remain moderate at 4.5% from 2.8% in 2019, in light of sluggish domestic demand, lower oil prices, and the temporary suspension of VAT on essential goods.

Political risks are rising. The disarmament process, envisaged in the peace agreement signed in August 2019 between the ruling Frelimo party and the main opposition party Renamo, has resumed in June after a hiatus of several months, as some Renamo factions continued to launch attacks. In parallel, terrorist attacks in the gas-rich northern region of Cabo Delgado have increased and expanded their reach in recent months.

ESG – Governance: Mozambique has an ESG Relevance Score of ‘5’ for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that World Bank Governance Indicators (WBGI) has in our proprietary Sovereign Rating Model. Mozambique has a low WBGI ranking at the 22th percentile, reflecting institutional weakness and governance shortcomings, as illustrated, for example, by the revelation in 2016 of hidden debt.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

In accordance with its rating criteria, for ratings in the ‘CCC’ range and below, Fitch’s sovereign rating committee has not utilised the SRM and QO to explain the ratings, which are instead guided by the rating definitions.

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 Long-Term Foreign-Currency 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

Factors that could, individually or collectively, lead to positive rating action/upgrade:

– Public Finances: Sustained easing of financing conditions, for example from an agreement on a medium-term IMF programme and wider official creditor support.

– Public Finances: A substantial decline in the public debt-to-GDP ratio, for instance as a result of a sustained reduction of financing needs, a restructuring of official creditor liabilities, or a positive resolution of outstanding SOE debt obligations.

– Macroeconomics: Higher confidence in medium-term growth prospects, through the timely coming on stream of the LNG megaprojects.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

– Increased likelihood of a probable default event or restructuring of sovereign market debt instruments.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].

KEY ASSUMPTIONS
We expect global economic trends to develop as outlined in Fitch’s most recent Global Economic Outlook published on 29 June 2020.

SOURCES OF INFORMATION

The principal sources of information used in the analysis are described in the Applicable Criteria.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Mozambique has an ESG Relevance Score of 5 for Political Stability and Rights, as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.

Mozambique has an ESG Relevance Score of 5 for Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as World Bank Governance Indicators have the highest weight in the SRM and are therefore highly relevant to the rating and a key rating driver with a high weigh.

Mozambique has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver. Mozambique cured the protracted default in 2019, and ongoing litigation surround unresolved public-sector liabilities still dents a full normalisation of the country’s relationship with creditors.

Mozambique has an ESG Relevance Score of 4 for Human Rights and Political Freedom, as World Bank Indicators have the highest weight in Fitch’s SRM and are therefore relevant to the rating and are a rating driver.

Mozambique has an ESG Relevance Score of 4 for Natural Disasters and Climate Change, as its macroeconomic conditions are exposed to the impact of natural disasters, which is relevant to the rating and is a rating driver.

Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies).