Fitch Ratings has downgraded Tunisia’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to ‘B+’ from ‘BB-‘. The Outlook is Stable.
The issue ratings on Tunisia’s senior unsecured bonds have also been downgraded to ‘B+’ from ‘BB-‘. Fitch has affirmed the Short-Term Foreign and Local Currency IDRs at ‘B’.
The Country Ceiling has been revised down to ‘BB-‘ from ‘BB’.
KEY RATING DRIVERS The downgrade of Tunisia’s IDRs to ‘B+’ with Stable Outlooks reflects the following key rating drivers and their relative weight: MEDIUM
The collapse of tourism in the context of elevated security risks, slowdown in investment amid frequent government changes and episodes of strikes and social unrest have weakened economic growth performance and prospects, with negative spill-overs to external and public finances. These can be seen in the widening of budget and current account deficits that have contributed to a rapid rise in public and external indebtedness. Security risks are elevated and incidents in recent years have led to a collapse in tourism, an important component of growth and foreign exchange inflows.
Measures have been taken to bolster the security apparatus following the terrorist attacks of 2015, and the failed attempt in March 2016 to take over Ben Guerdane near the Libyan border.
These have averted further attacks so far, but risks remain high, given the insecurity in Libya and high unemployment that is fuelling unrest and youth radicalisation.
Another threat arises from Tunisian fighters returning home after suffering battlefield defeats abroad. Fitch estimates GDP growth for 2016 at 1.2%, compared with a pre-revolution long-term average of 4.5%, and versus medians of 4.0% for ‘B’ peers and 3.5% for ‘BB’ peers. Inflows from tourism continued to slow, though at a moderating pace (down 8% yoy in September, versus a 38% decline in 1H16).
Fitch projects GDP growth of 2.3% in 2017 and 2.5% in 2018, reflecting higher private consumption that will be supported by wage rises, a modest recovery in tourism inflows, and a faster pickup in investments that will be aided by the adoption of a new investment code in 2016 and the momentum generated at November’s 2020 conference. Fitch’s estimate for the 2016 general government deficit of 6.4% of GDP (incorporating a 5.8% of GDP central government deficit and projected social security and local government balances), is about 2pp of GDP higher than the original budget target, and an increase from 5.2% in 2015. The slippage can be partially attributed to temporary factors, including the need to hire security personnel, which contributed to an increase in the wage bill (now at 14.6% of GDP), and the lower than budgeted GDP growth. This led to an increase in 2016 gross general government debt (GGGD) to almost 64% of GDP, versus medians of 51% for ‘BB’ peers, and 56% for ‘B’ peers.
The weaker 2016 starting point, and protracted negotiation process for the 2017 budget reduces Fitch’s confidence in the government’s ability to meet future fiscal targets. We project the budget deficit will remain elevated at around 6% of GDP to 2018. Political opposition resulted in the withdrawal of government proposals including a wage freeze to 2018. The cost of the cancelled measure will be partly offset by a planned pause in hiring, but the wage bill is still forecast by Fitch to consume around 70% of primary current spending this year, leaving little room for consolidation. According to our projections, GGGD-to-GDP will surpass 70% by 2018. Fitch estimates that the government will need to borrow the equivalent of 7% of GDP externally (in addition to 2.8% of GDP in domestic market financing) to meet its amortisation and budget needs in 2017. Around 55% of the foreign funding will come from multilateral and bilateral lenders, with the remainder to be financed through market issuances, including a Eurobond offering expected in 1Q17.
Tunisia continues to enjoy support from the international community, which provides it with foreign currency liquidity, moderates external interest service, and extends the debt maturity profile. However, the growing reliance on foreign creditors subjects Tunisia to uncertainty should it fail to deliver on reform benchmarks. A large portion of concessional financing (including from the EU and World Bank) is directly or indirectly tied to performance under the IMF programme signed in 2016. Progress in a number of areas has been slow to date, including in public administration and financial sector reform.
In Fitch’s opinion, financing risks related to disbursement delays (due to non-compliance) cannot be ruled out. Increased reliance on foreign financing has also rendered public debt vulnerable to exchange rate fluctuations. With 63% of GGGD denominated in foreign currency, the dinar depreciation in 2016 (9% against the euro and 13% against the dollar) is estimated by the government to have resulted in a 13% increase in the foreign debt stock, at a cost of 4.3% of GDP.
The current account deficit of 8.9% of GDP in 2016 was roughly unchanged from 2015 and reflected still low tourist inflows and declines in agriculture and energy exports.
Fitch projects that the deficit will widen to 9.3% of GDP by 2018, as a gradual recovery in tourism inflows will be offset by declining oil production and rising prices impacting imports. The balance of payments gap and subsequent pressure on the dinar are reflected in an external payment reserve cover of just three months at end-2016 (versus a ‘B’ median of 3.9).
Fitch estimates net external debt at 46% of GDP in 2016, more than double the ‘B’ median. Fitch forecasts it will surpass 50% of GDP by 2018. Tunisia’s ‘B+’ IDRs with Stable Outlooks also reflect the following key rating drivers: Tunisia has made progress in a number of reform areas, including passing banking legislation and investment code, preparing an organic budget law, and committing to a four-year IMF programme in 2016. Reform implementation risks remain high. Resistance to reforms will continue, given the delicate social and security contexts, despite the broader composition of the new government. Municipal elections (expected in 2017) and vested interests may further complicate the process.
The adoption of new banking sector legislation in 2016 was a step towards restructuring the weak state-owned enterprises. Fitch considers the likelihood of another capital injection to be high, despite a recapitalisation exercise in 2015 that improved solvency (albeit with no downside buffers). Other contingent liabilities for the government include debt guarantees of state enterprises and potential liquidity needs stemming from the pension funds.
Tunisia is a strong outperformer relative to the ‘B’ category in structural features including GDP per capita, human development and governance, depth of financial markets, and ease of doing business indicators.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch’s proprietary SRM assigns Tunisia a score equivalent to a rating of ‘BB-‘ on the Long-Term FC IDR scale. Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
– Structural factors: -1 notch, to reflect high security, political, and social risks, which continue to impact growth, external and public finances.
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 LT FC 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 Outlook is Stable, which means Fitch does not expect developments with a high likelihood of leading to a rating change. However, the main factors that could lead to positive rating action are:
– Increased growth prospects, for example related to structural improvements in the business environment and/or the security situation. – Reduction in budget deficits consistent with lowering the debt-to-GDP ratio in the medium term.
– A structural improvement in Tunisia’s current account deficit, leading to reduced external financing needs and stronger international liquidity buffers.
The main factors that may individual or collectively lead to negative rating action are: – Political destabilisation of the country, for example from major terrorist attacks or social unrest, with adverse impact on the nascent economic recovery
– Worsening of the fiscal deficit or a materialisation of a contingent liability leading to an increase in government debt/GDP
– Continued weakening in external finances, such as a widening of the current account deficit and renewed pressure on international reserves leading to a marked increase in net external debt-to-GDP
Fitch Ratings’ Report