Moody’s Investors Service, (“Moody’s”) has Rwanda’s outlook to negative from stable and affirmed the B2 long-term issuer rating.
The negative outlook reflects the risks the coronavirus pandemic may durably impair certain sectors of the economy, such as transportation and tourism, potentially lowering the returns on past government investment. Lower growth in turn would make fiscal consolidation more challenging, raising the credit risks associated with Rwanda’s relatively high debt burden, which had been rising before the coronavirus shock and is being exacerbated by it.
The affirmation of the B2 rating is supported by limited financing risks despite the increase in borrowing requirements. External financing provided by multilateral institutions and other development partners will help meet the government’s larger financing needs and limit immediate liquidity pressure. The B2 rating is also supported by the government’s track record of effective policymaking and macroeconomic management, leveraging support from international financial institutions.
These credit strengths are set against Rwanda’s small size and low income levels, which severely constrain the sovereign’s shock absorption capacity despite its historically very high growth rates. The rating affirmation also takes into account Rwanda’s elevated susceptibility to event risk, mainly driven by political risks and external vulnerability risk.
Rwanda’s local-currency bond and deposit ceilings remain unchanged at Ba2. The foreign-currency bond and deposit ceilings also remain unchanged at B1 and B3, respectively.
The coronavirus shock calls into question Rwanda’s largely debt-financed development model which focused on increasing trade and promoting Meetings, International Conferences, and Events (MICE) activities.
Prior government investment has driven strong growth of exports, such as tourism and transport services, while Rwanda has increasingly positioned itself as a transit hub and re-exports of goods from East Africa’s ports and Democratic Republic of the Congo. The associated large upfront capital costs, which have been reflected in a growing debt burden before the pandemic, were to be absorbed by persistent high growth, foreign currency earnings and government revenue in the future.
Risks to Rwanda’s medium-term growth prospects are now tilted to the downside. Rwanda is vulnerable to persistently weak demand and changes in behavioral patterns in the aftermath of the pandemic. Rwanda’s investment in the transport and tourism sectors may see lower future returns should travel demand and international trade remain below pre-coronavirus expectations for a significant period of time. Should these downside risks materialize, Rwanda will be left with a higher debt burden without realizing the higher value-added growth necessary to generate foreign exchange earnings and tax revenue to service the associated higher debt load.
CORONAVIRUS SHOCK WILL WIDEN ALREADY LARGE FISCAL IMBALANCES, WHICH IF NOT REVERSED, WILL REDUCE RWANDA’S DEBT SERVICE CAPACITY
The coronavirus shock has exacerbated a trend of weakening fiscal strength, which was underway prior to the crisis. Lower growth together with fiscal stimulus in response to the crisis will widen the fiscal deficit, resulting in Rwanda’s debt burden rising to over 70% of GDP by fiscal 2021 (fiscal year ending June 30, 2021) compared with 52% of GDP in fiscal 2019.
The higher debt burden leaves the sovereign with less fiscal space to absorb future shocks. Unless the deterioration in the fiscal balance is reversed, Rwanda’s liquidity risks will increase given its limited financing options. Immediate liquidity risks are contained as Rwanda’s larger financing needs will be met through concessional loans from international financial institutions. Given Rwanda’s limited financing options, larger financing needs would put pressure on the sovereign’s debt servicing capacity.
A high share of foreign-currency-denominated debt (over three-quarters of total debt), which exposes the government’s fiscal strength to a marked depreciation of the currency. Additionally, the stock of government guarantees represents a contingent liability to the government. Government guarantees stood at 4.5% of GDP at the end of 2019. Some of these guarantees were provided to key state-owned enterprises (SOEs) like Rwandair, the Kigali Convention Center, and the Bugesera Airport, which are being severely negatively affected by the coronavirus shock. Given the strategic importance of these SOEs, Moody’s expects the government to provide support if necessary.
RATIONALE FOR THE RATING AFFIRMATION
The rating affirmation reflects Rwanda’s limited financing risks given its reliance on concessional external borrowing. Rwanda’s heavy reliance on concessional financing helps to mitigate some of the credit risks associated with a rising debt burden, as interest affordability remains high. Rwanda has a track record of effective policy implementation and reform, leveraging support from international financial institutions, which support the formulation and implementation of sound macroeconomic policies. This increases the likelihood the government will be able to enact corrective policies to stabilize the debt burden when the economy recovers from the coronavirus shock, ultimately preserving debt service capacity.
These credit strengths are set against Rwanda’s small size and low income levels, which limit diversification and severely constrain the sovereign’s shock absorption capacity. Rwanda’s favorable debt structure and high debt affordability will help to mitigate the risks associated with a higher debt burden. The large share of concessional debt limits the interest burden. Even taking into account lower revenue, Rwanda’s interest burden will increase to just 7% of revenue in 2020, which compares favorably to the B-rated median of 10%.
Persistently large current account deficits expose Rwanda to event risk. The immediate risks are limited by ample foreign exchange reserves, which while expected to decline in 2020, remain adequate to cover upcoming external debt servicing needs. International financial institutions will provide financing to meet Rwanda’s larger external financing needs created by the coronavirus shock. Furthermore, Moody’s expects Rwanda’s current account deficit to narrow based on a recovery in exports of goods and services. Uncertainty over the succession to President Paul Kagame and long-standing frictions with neighboring countries point to high political risk. A rise in political risk could reduce foreign investment, delay donor funding, pressure the country’s balance of payments and increase liquidity pressures.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental considerations weigh on Rwanda’s economic strength and credit profile. Given the importance of agriculture in GDP, employment and income, recurring droughts can have a significant negative impact on the agriculture sector and overall economic output. The low wealth levels limit the ability of households to buffer the impact of lost earnings because of weather-related events. That is why Moody’s identified Rwanda as one of those countries whose credit profile is most susceptible to climate change.
Social considerations are also material to Rwanda’s credit profile. Credit challenges include low income levels and high poverty rates. Moody’s regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. For Rwanda, the potential long-term impact of the pandemic on transport and tourism threatens the government’s capacity to stabilize and reverse a relatively high debt burden.
In terms of governance, Rwanda performs relatively strongly compared to Sub-Saharan African neighbors on institutional factors that are captured in Moody’s assessment of institutions and governance strength, and are important considerations in the government’s ability to advance its reform agenda and allow the country to develop an institutional framework conducive to economic development and macroeconomic stability.
On 08 October 2020, a rating committee was called to discuss the rating of the Rwanda, Government of. The main points raised during the discussion were: The issuer’s institutions and governance strength, have materially decreased. The issuer’s fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptible to event risks.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The negative outlook signals that a rating upgrade is unlikely over the near term. The outlook would likely return to stable on signs the government is able to implement a faster and sustained fiscal consolidation that would reduce debt over the medium term. Moody’s would also return the outlook to stable if it were to determine the coronavirus shock would not have a lasting impact on key growth and foreign exchange generating sectors such as tourism and transportation, which would result in a faster improvement in fiscal and external imbalances.
Moody’s would lower the rating if it became increasingly clear that Rwanda’s growth prospects had materially diminished compared to pre-crisis projections, lowering the expected return on publicly-financed capital projects. As a result, debt would rise faster and further than currently expected by Moody’s to high levels that would over time weaken the government’s liquidity position. Furthermore, a downgrade is likely if Rwanda’s external position fails to improve in the foreseeable future, with additional pressure on reserves that raises external vulnerability risk.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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