Fitch drops Lesotho’s credit rating

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Bereng Mpaki

GLOBAL rating agency, Fitch Ratings has downgraded Lesotho’s international credit ratings citing the decline in South African Customs Union (SACU) revenues and perceptions of political instability which have impacted on investor confidence in the country.

In its latest rankings released last week, Fitch revised downwards the country’s long-term foreign currency Issuer Default Rating (IDR) from ‘BB-’ to ‘B+’ status.

The long-term local currency IDR was also revised downwards from ‘BB’ to a ‘BB-’ status.

Fitch’s international credit ratings relate to either foreign currency or local currency commitments and in both cases, assess the capacity to meet these commitments using a globally applicable scale.

The local currency rating measures the likelihood of repayment in the currency of the jurisdiction of the country. On the other hand, the foreign currency ratings consider the profile of the issuer or note after taking into account transfer and convertibility risk.

‘BB’ ratings indicate an elevated vulnerability to default risk, particularly in the event of adverse changes in business or economic conditions over time.

The modifiers ‘+’ or ‘-’ may be appended to a rating to denote relative status within major rating categories.

‘B’ ratings indicate that material default risk is present, but a limited margin of safety remains. It means that financial commitments are currently being met but the capacity for continued payment is vulnerable to deterioration in the business and economic environment.

In a statement, Fitch attributed the decline to prevailing economic and governance developments.

“Medium Fitch forecasts a continued deterioration in public finances, with projected deficits of 3.4 percent of GDP in fiscal year-ending March 2016 (FY16), 6.8 percent of GDP in FY17 and 6.5 percent of GDP in FY18,” the agency said.

“The widening deficit is due to the fall in South African Customs Union (SACU) revenues linked to the weakening in South Africa’s economic performance.

“SACU receipts are forecast to drop to 16.6 percent of GDP in FY17 from 25.8 percent of GDP in FY16, and remain at around 18 percent of GDP in FY18. The authorities have not adjusted fiscal policy in response.

“Expenditure on wages is expected to remain very high at 23.7 percent of GDP in FY16 and FY17. The deficit will be funded from government deposits, which are forecast to fall to 19 percent of GDP in FY18 from 26 percent of GDP in FY16, and new government debt issuance.”

Fitch also predicted further deterioration in the status of the government debt.

“Fitch forecasts gross general government debt (GGGD) to increase to 56 percent of GDP by FY18 from 52.5 percent of GDP in FY16 as a result of new debt issuance and Loti depreciation, as around 85 percent of GGGD debt is in foreign currency. In FY17 Lesotho’s GGGD is forecast to exceed the peer ‘B’ median of 54.4 percent of GDP. GGGD is mostly concessional with long maturities. Political tensions are complicating any policy response to the growing fiscal deficit,” the organisation said.

The organisation noted that the prevailing “political tensions are complicating any policy response to the growing fiscal deficit”.

“The governance and institutional environment have weakened significantly following an alleged coup attempt in 2014, as evidenced by the deterioration in Word Bank governance indicators. The recent South African Development Community (SADC) commission of inquiry report on its investigation into the death of a former army general highlights the institutional weaknesses.”

Fitch said it did not expect meaningful improvement in the political environment in the short-term.

As a result, the organisation predicted “continued weak real GDP growth in 2015 and 2016 due to ongoing political tensions, a drop in SACU revenues and a recent drought.”

“The political tension has hit investment, consumption and confidence, affecting the implementation of the National Strategic Development Plan (NSDP). Fitch forecasts GDP growth of 2.8 percent in 2016 up slightly from 2.7 percent in 2015, before increasing to 4 percent by 2017 as new mining production comes on stream and initial work on phase II of the Lesotho Highlands Water Project (LHWP) boosts the construction industry.

“Donor relations are becoming increasingly strained. Disquiet regarding the political situation led to a loss of EU budget support in 2016 and has generated uncertainty regarding re-certification for the African Growth and Opportunity Act (AGOA). AGOA is very important to the textiles sector, a key component of Lesotho’s economy, as it provides preferential access to the US market.”

Fitch also forecast the current account deficit (CAD) to widen to 14 percent of GDP in 2016 from 8 percent of GDP in 2015 due to the drop in SACU revenues in 2016 before returning to around 8 percent of GDP in 2017.

“The CAD is due to ongoing construction of projects in the country. A combination of grants and FDI will fund the CAD,” Fitch noted.

The organisation further forecast international reserves to fall to four months of current external payments in 2017 from 4.7 months in 2015, although this would be adequate to support the exchange rate peg.

Fitch identified further material weakening of debt ratios and an erosion of government deposits as well as political turmoil as the main factors that could individually or collectively lead to a negative rating action.

On the factors that could lead to a positive rating, the organisation identified higher real GDP growth supported by an improvement in the business environment and political stability and diversification in the economy.

“Further progress in diversifying the revenue base and growing tax receipts that lessen the dependence on SACU revenues as well as a sustained reduction in GGGD/GDP,” were identified as other factors that could lead to a positive rating.

Fitch also made assumptions that economic growth in Lesotho would be supported by a gradual recovery in its key economic partners, namely the US, Europe and South Africa.

“Fitch also assumes there will be no major revision to the SACU revenue-sharing formula that could negatively affect SACU revenues to Lesotho. Fitch also assumes AGOA will be recertified in 2017,” the organisation said.

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