The three top agencies gave Ethiopia her first sovereign credit ratings, as per her application in late 2013. Sovereign credit rating is a grading of a country’s ability to meet its financial obligations. States often seek the rating to enhance their access to international finance markets, while investors use it as an indicator of the level of risk associated with investing in a country.
On May 09, 2014, the three popular firms, Standard & Poor’s(S&P) Ratings Services, Moody’s Investors Service and Fitch Ratings announced their rating of Ethiopia’s creditworthiness as B, B1 and B, respectively.
The news has brought much hoopla in government circles and was said to be, in Minister Sofian Ahmed words, “a confirmation of the convictions and beliefs of the government”.
However, these ratings are new to the nation as well as to the readers of HornAffairs.
Therefore, we invited Dr. Costantinos Beruh Tesfa Berhe, to help us make sense of the news.
Costantinos Berhutesfa Costantinos, PhD, Professor of Public Policy at School of Graduate Studies, College of Business and Economics, of Addis Ababa University. Also, Chair of Ethiopica Infrastructure & Tunneling Co. & AAI Capital. His area of work include participatory policy analysis, formulation and management – local institutions, civil society development, and strategic planning and resource management as a senior adviser for a number of international and regional organizations such as AU, EU, UNDP, UNECA, UNICEF, and countries in Africa. He is author of numerous papers published in professional journals, presented to workshops and symposium. Recently he has written serious of books on governance, resource management and climate change adaptation.
Dr. Costantinos: Ethiopia has been borrowing funds for development from various sources such as the World Bank, African Development Bank, China, India and various EXIM Banks & commercial entities in the West. Each loan provided by funding nations or agencies has its own internal rationale and assessment. For instance, development bank loans such as the World Bank impart their loans at low interest rates (soft loans) or at concessionary rates. Nevertheless, Ethiopia needs to widen its loan base from available international sources for both public and private sector investment. Hence, it is imperative for a sovereign credit rating as an assessment of its credit worthiness to enable it to borrow funds.
Based on substantial due diligence, sovereign credit assessment and evaluation is generally done by a credit rating agency such as Fitch, Standard & Poor’s or Moody’s. Ethiopia will obviously strive to have the highest possible credit rating since it has a major impact on the ability to borrow funds and the interest rates lenders charge it, because credit rating has an inverse relationship with the possibility of debt default. In the opinion of the rating agency, a high credit rating indicates that the borrower has a low probability of defaulting on the debt; conversely, a low credit rating suggests a high probability of default.
The rationale for the credit rating also stems from the fact that Ethiopia has been a closed state-run economy for much of the last four decades. The nationalization of private property by the previous regime heralded the advent of ‘socialism’ that still lingers on in major sectors of the economy. This has a major impact on attracting foreign direct investment (FDI) in terms of business confidence, government interference and stability of markets. Hence, to be able to attract FDI, these ratings accompanied by a post of credit and capital market reform measures are important for investors who would in turn have to depend on foreign banks availing the loans to them to invest in Ethiopia, and of course, to pay back their debts.
HornAffairs: What exactly do the ratings assigned to Ethiopia tell us?
Dr. Costantinos: Credit rating agencies typically assign letter grades to indicate ratings. Standard & Poor’s, for instance, has a credit rating scale ranging from ‘AAA’ (excellent) and ‘AA+’ all the way to ‘C’ and ‘D’. A debt instrument with a rating below BBB- is what rating agencies consider speculative grade or a junk bond. Credit rating changes can have a significant impact on financial markets.
The table here (see below) shows the sovereign debt credit rating as reported by the major credit rating agencies for Ethiopia.
In general, sovereign wealth funds, pension funds and others investors use the ratings to gauge the credit worthiness of Ethiopia thus having a big impact on the country’s borrowing costs use a credit rating. Fitch Ratings has assigned Long-term foreign and local currency Issuer Default Ratings (IDRs) of ‘B’, Short-term foreign currency IDR of ‘B’ and a Country Ceiling of ‘B’. The Outlooks on the Long-term IDRs are STABLE.
According to Fitch, the key rating drivers reflect a “balance between weak structural features indicating vulnerability to shocks and strong economic performance and improved public and external debt ratios since debt relief under HIPC in 2005-2007. More specifically, the ratings reflect the following key rating drivers: despite impressive improvement over the past decade, Ethiopia’s ratings are constrained by a weak level of development. The country ranks among the weakest Fitch-rated sovereigns on UN human development indicators, with a GDP per capita of USD500 in 2013, well below ‘B’ medians. Governance indicators as measured by the World Bank are broadly in line with ‘B’ medians. -Economic performance is strong. However, the private sector’s weakness, reflecting the country’s fairly recent transition to a market economy, and its inadequate access to domestic credit, could limit growth potential over the medium-term as public investment slows.” (Fitch Ratings, 2014)
On the other hand, with an average real GDP growth of 10.9% over the past five years, Ethiopia has outperformed regional peers due to significant public investments in infrastructure as well as growth in the large agricultural and services sectors. Despite a record of accomplishment of high and volatile inflation, it declined significantly in 2013, reflecting lower food prices and the authorities’ commitment to moderate central bank financing of the government. Fitch expects real GDP growth of 9% in 2014 and 8% in 2015. Large, untapped resources, including large hydroelectric potential, can sustain Ethiopia’s growth over the medium-term.
According to the National Bank of Ethiopia, Ethiopia recorded a Government Debt to GDP of 25.70 percent of the country’s Gross Domestic Product in 2012. Government Debt To GDP in Ethiopia averaged 34.18 percent from 1992 until 2012, reaching an all time high of 41.80 percent in 2002 and a record low of 24.70 percent in 1998. Generally, investors to measure a country ability to make future payments on its debt use Government debt as a percent of GDP. It thus affects the country borrowing costs and government bond yields.
Ethiopia recorded a Current Account deficit of 6.40 percent of the country’s Gross Domestic Product in 2012/13 fiscal year. Current Account to GDP in Ethiopia averaged -3.04 Percent from 1981 until 2013, reaching an all time high of 1.82 Percent in 1994 and a record low of -12.74 Percent in 2005. The National Bank of Ethiopia reports the Current Account to GDP in Ethiopia. The Current account balance as a percent of GDP provides an indication on the level of international competitiveness of a country. Usually, countries recording a strong current account surplus have an economy heavily dependent on exports revenues, with high savings ratings but weak domestic demand. On the other hand, countries recording a current account deficit have strong imports, a low saving rates and high personal consumption rates as a percentage of disposable incomes.
“Despite large capital expenditure, the general government (GG) budget deficit remained contained to an average 1.4% of GDP over the past five years, due to low levels of current spending, including a limited wage bill and modest interest payments. As a result, headline GG debt declined steadily in 2005-2012 following the 2005 HIPC/MDRI debt alleviation, and reached 25.8% of GDP in June 2013, well below the ‘B’ median and regional peers”. (Fitch Ratings, 2014).
HornAffairs: The ratings put Ethiopia in the same cluster with other strong African economies, which have a much more, liberalized financial and investment regime (e.g. Ghana, Zambia, Kenya) Can this be taken as a validation Ethiopia’s current economic direction?
Dr. Costantinos: As stated above, the estimates for the total SoE debt amounted to at least 25% of GDP at end-June 2013, doubling consolidated total public debt. Structural current account deficit – at 5.4% of GDP in 2013 – reflects low value-added exports and investment-related imports. It exerts pressure on international reserves, which in comparison with peers at two months of current account receipts, are low. However, with debt service also is low, reserves relative to debt service are above the ‘B’ median. Net external indebtedness has risen steadily since 2007, though it remains moderate and in line with ‘B’-rated peers. However, growing recourse to non-concessional financing, particularly by SoEs, could increase debt service.
The Stable Outlook reflects credit ratings assessments that upside and downside risks to the rating are currently well balanced. The main factors that could lead to a positive rating action, individually or collectively, are stronger external indicators, including higher exports, as well as stronger FDI and international reserves, a sustained decline in inflation reflecting an improved macro-policy environment and further improvement in structural factors, including stronger development and governance indicators.
The main factors that could lead to a negative rating action, individually or collectively, are rising external vulnerability related to declining international reserves, widening current account deficit or rising external indebtedness, increased risk of contingent liabilities from SoEs and publicly owned banks materializing on the government’s balance sheet. Hence, the ratings are reliant on a number of assumptions, including continuity in the development model of the country, continued strong support from the international community and implying continued aid inflows to the country to support its development. Moreover demand for its exports (including coffee, other agricultural products and gold) benefiting from the gradual recovery in the global economy, with world GDP growth forecast to increase to 2.9% in 2014 and 3.2% in 2015 from 2.3% in 2013 -No major change in the political regime in the coming years.
The comparison with liberalized economies such as Ghana and Kenya predicates itself on state business and political party endowments that play significant part in the financing of large part of investments through heavy domestic borrowing bank credit that have significantly increased investments in infrastructure (including roads, electricity and railways). Nevertheless, this statement should not be an indictment of the economic policy trajectories at play in Ethiopia today. What is uncommon in relation to such views is the opportunity cost Ethiopia is absorbing for lack of foreign financial and credit institutions, foreign direct investment in telecommunications, shipping lines, airlines and heavy industry that have hampered organic growth that could have contributed to translate to livelihood security to its citizens and a more robust transformation for the country. We estimate that the economy could have achieved the GTP target of 14.5% growth planned if the above factors were addressed.