Sunday 13, August 2017 by Georgina Enzer

Angola Downgraded To 'B-' on rising debt service costs, weak economic prospects; outlook stable

On 11 August 2017, S&P Global Ratings lowered its long-term foreign and local currency sovereign credit ratings on the Republic of Angola to 'B-' from 'B'.

We affirmed the short-term foreign and local currency sovereign credit ratings at 'B'. The outlook is stable. The downgrade reflects our view of lower fiscal revenue and rising debt service costs against the backdrop of a further weakening of economic performance in 2016 that we forecast to continue in 2017-2020.

OUTLOOK

The stable outlook reflects our view that current account deficits will remain high but can be financed externally without significantly dragging on Angola's foreign exchange reserves. We also expect government liquid assets will not decrease substantially.

We could consider lowering the ratings on Angola if we see potential risks to its commercial obligations either due to fiscal stress or a weakening political or institutional environment after the 2017 elections.

We could raise the ratings on Angola if we observe the new administration implementing economic reforms that support faster economic growth, reducing the fiscal and external risks.

RATIONALE

The downgrade reflects our view of lower fiscal revenue and rising debt service costs against the backdrop of a further weakening of economic performance in 2016 that we forecast to continue in the next few years. Angola's debt service costs have increased faster than we had expected. This acceleration is due to higher government borrowings in the domestic market to finance fiscal deficits, in an environment of high domestic yields. The increase in debt has also come at a time when oil revenues are still weak. We estimate that debt service will have increased to above 15 per cent of government revenues in 2017, from seven per cent in 2015.

The non-oil sector--which contributes around 60 per cent to GDP, and which we expected to help drive a higher pace of economic growth--is facing a sharper slowdown than we expected as foreign currency supply constraints hamper import-dependent industries, such as construction and retail. Due to low oil prices and delays in government approvals, new investment in the Angolan oil sector is likely to be weak, undermining the oil sector's contribution to economic growth over the medium-to-long term. In addition, the government's capital expenditures, which contribute significantly to economic growth, have also been cut as part of a fiscal consolidation plan. The economic slowdown reflects a combination of the still-declining contribution from the oil sector and insufficient supply of foreign currency constraining the productive sectors of the economy. We estimate that 2016 real GDP growth was just above 0 per cent, and we have cut our 2017-2020 forecast average to 2.3 per cent from 3.3 per cent.

The banking sector also remains weak following reduced credit demand and supply conditions, with weak risk management leading to high nonperforming loans and liquidity challenges. Some of the major systematically important, state-owned banks are in the process of being restructured, and are considering selling bad loans. The state has created a new government-owned asset management company, Recredit, to buy bad debts mainly from state banks and some private sector banks as well. The size and capacity of the asset manager is still being established. If the asset management company were to incur debt liabilities, we would likely consider this as part of general government debt.

Institutional and Economic Profile: Relative political stability under President Dos Santos' leadership has been maintained, and a succession process is about to be tested

• Angola is likely to have a new leader, Joao Lourenco, after the elections on 23 August, 2017, if the ruling MPLA party retains its majority in parliament, as we assume.

• However, it is unclear if Mr. Dos Santos will fully relinquish political power as head of the MPLA or how much room Lourenco may get to set his own economic agenda and improve the currently weak economy.

• The economy remains weak as foreign currency shortages continue to strain key sectors. Weak oil and non-oil sector performances have led to downward revisions of our economic growth forecasts.

Angola has maintained relative political stability under the leadership of the current president, José Eduardo dos Santos, and the People's Movement for the Liberation of Angola (MPLA). While government institutions are slowly improving the policy environment, we still view decision-making as highly centralised and sometimes uncertain. The upcoming parliamentary election later this month offers Angola an opportunity to test its succession process as the longstanding president steps down. We assume the MPLA party is likely to retain its majority in parliament and thus Joao Lourenco will emerge as the country's new president. However, Dos Santos is likely to remain the MPLA party leader, potentially creating two centres of power. At this stage, it is unclear if Dos Santos will fully relinquish political power as head of the MPLA and how much room Lourenco may get to set his own economic agenda. Such an agenda could entail reforms on the exchange rate regime, oil sector reforms, and efforts to diversify the non-oil economy.

In 2016, we estimate that real GDP growth slowed to 0.2 per cent of GDP due to a continued decline in oil investment over the course of the year, and because of a contraction in the industrial sector from shortages of foreign currency to import raw materials and industrial components, among other factors. We estimate that there will be a modest improvement in GDP growth to above one per cent in 2017, further picking up over 2018-2020. Our 2.3 per cent real GDP growth average forecast over 2017-2020, below our previous forecast of 3.3 per cent, assumes limited new investments in the oil sector as oil majors and Sonangol have been slower at signing new oil investment projects. We also assume stable oil production in the near term, as well as a gradual increase in oil prices (see S&P Global Ratings Raises Its Oil and Natural Gas Prices Assumptions For 2017, published on 14 December, 2016, on RatingsDirect). Improvements in the oil sector normally have a positive impact on non-oil sectors, due to linkages to the oil industry through supply contracts, for instance.

We now expect Angola's wealth levels, as measured by GDP per capita, will remain close to $4,000 until 2020. While we see potential recovery in the agriculture sector and improvements in diamond production and prices over the medium term, economic diversification is still slow in Angola, which limits its ability to absorb oil-sector shocks to the economy.

Flexibility and Performance Profile: Angola faces pressure from large current account deficits, rising debt servicing costs, and a weak banking sector

• Debt service costs are rising with higher borrowings and weak fiscal revenues.

• The banking sector remains weak, with some important state banks going through a restructuring process.

• Current account deficits will remain sizable over the forecast horizon.

Since 2014, the reduction in oil revenues has exerted pressure on Angola's external accounts, highlighting the country's dependency on oil export revenues (95 per cent of total exports) and vulnerability to terms-of-trade shocks. Oil export receipts have fallen substantially over the last three years, while the import of goods and services have fallen by a smaller margin, resulting in wide current account deficits in 2015 and 2016. Going ahead, we expect that current account deficits will average 7 per cent in 2017-2020, which is lower than our previous forecasts of 7.5 per cent.

We assume that oil prices will gradually improve, goods and service imports will increase at a slower pace, and the supply of foreign currency will remain low, inhibiting faster import growth. We expect Angola's gross external financing needs will remain above 100 per cent of current accounts receipts plus useable reserves over 2017-2020, while narrow net external debt will remain below 100 per cent of current account receipts over the same period. Angola's external financing remains concentrated in foreign direct investment (mainly in the oil sector), and external borrowing by both public and private sectors (half of whose external borrowing is short term).

The government continues to revise its fiscal plans along with the changes in the oil spot prices, as the proportion of oil revenues has declined from at least two-thirds of total fiscal revenue in 2014 to one-half in 2016 and 2017. We estimate a preliminary fiscal deficit outcome of 2016 at 2.4 per cent of GDP, similar to 2015 (2.8 per cent), based on government fiscal statistics. However, we forecast an annual change in debt for 2016-2017 of above six per cent of GDP, partly due to higher borrowings and exchange rate depreciation, which accentuate the external debt component.

We estimate that the annual change in general government debt will gradually decline to average three per cent of GDP over 2017-2020 in line with our oil price assumptions, expenditure adjustments, and higher non-oil revenue. The government is working on ways to implement VAT after 2020, which may boost non-oil revenues, but only outside our current forecast horizon. We believe the government will retain a deficit target of around five per cent of GDP in 2017, which can accommodate spending related to the August 2017 elections, while the deficits will decline to about two per cent of GDP by the end of 2020. The fiscal consolidation projections are consistent with our assumptions of a gradual increase in oil prices supporting fiscal revenues. Thus, in our base-case scenario (we assume no fiscal stimulus and a stable exchange rate), the annual change in general government debt should average three per cent of GDP over 2017-2020 (compared to over six per cent of GDP in 2014-2016).

Angola's weakening currency, which has depreciated by more than 60 per cent in the past three years, has inflated the country's fiscal debt burden given that one-half of Angolan government debt is denominated in foreign currency.

Therefore, Angola's gross general government debt increased substantially in 2016 to 54 per cent of GDP from 30 per cent in 2014. Over 60 per cent of the commercial debt is held by nonresidents, mainly bondholders and international commercial banks. Local banks' holdings of government securities is around 30 per cent of total banks' assets, reflecting limited diversification in the investor base and narrow domestic capital markets.

The increase in debt has accompanied a combination of rising debt service payments and declining revenues. We estimate interest expenditure will have increased to above 15 per cent of revenue in 2017 from seven per cent in 2015. We expect that the interest-to-revenue ratio will stay above 15 per cent over 2017-2020 as oil-related government revenues improve more gradually. Angola's fiscal position is supported by a large liquid asset base of close to 20 per cent of GDP, including a $5 billion sovereign wealth fund and $8 billion deposited at the central bank on behalf of the government. This reduces net general government debt to an average of 35 per cent of over our forecast period.

Although the US dollar-Angolan kwanza (AOA) exchange rate has been relatively stable at AOA166 to $1 for most of 2017, we also note that Angola's central bank (Banco Nacional de Angola; BNA) has allowed the kwanza to weaken by at least 60 per cent since 2014. We view the changes in the exchange rate levels as consistent with a managed floating exchange-rate system, similar to other 'B' rated sovereigns in the region.

However, the weakening exchange rate, along with the reduction of fuel subsidies and rising food prices, stoked inflation to close to 40 per cent year on year by the end of 2016. To contain inflation, BNA tightened monetary conditions by raising the reserve requirement ratio and policy rates over the second half of 2016. Inflation has started to slow down, standing at close to 30 per cent year on year in June 2017 from the level of 40 per cent in December 2016. We expect inflation to gradually reduce to eight per cent in 2019, reaching the central bank's target of seven per cent to nine per cent. As of 31 July, 2017, the BNA has maintained its policy rate at 16 per cent, since it believes inflation is slowing down.

The smooth functioning of the foreign exchange market is inhibited by the central bank's restrictions to current account transactions and BNA as the sole supplier of foreign exchange to the financial system. The banking sector remains weak following reduced credit demand and supply conditions, weak risk management leading to high nonperforming loans, and liquidity challenges. Some of the major systematically important, state-owned banks are in the process of being restructured and are considering selling bad loans. The state has created a new government-owned asset management company, Recredit, to buy bad debts, mainly from state banks and from some private sector banks as well. The size and capacity of the asset manager is still being established. If the asset management company were to incur debt liabilities, we would likely consider this as part of general government debt.

 

 

Features & Analyses