Wednesday 02, August 2017 by Matthew Amlôt

Moody's downgrades the Republic of the Congo's rating to Caa2, outlook remains negative

Moody's Investors Service has today downgraded the long-term local and foreign currency issuer ratings of the government of the Republic of the Congo (ROC) to Caa2 from B3 and maintained the negative outlook.

Concurrently, Moody's has lowered the ROC government's local currency and foreign currency long-term bond and deposit ceilings to B2 from Ba3.

The key drivers behind the two notch rating downgrade to Caa2 from B3 and the change in ceilings are:

1) Moody's expectation that the ROC government will imminently default on its Eurobonds and could remain in default for a protracted period of time

2) Increasingly acute liquidity pressures that could ultimately lead to sizeable losses for private sector creditors in the coming years

The negative outlook reflects the risks that private sector creditors could incur greater losses than are currently anticipated by Moody's Caa2 rating.

The government of ROC missed a $21 million coupon payment on its sole outstanding Eurobond. This will become a default event under Moody's definition of default unless payment is made before the 30 day grace period expires at the end of July.

On 26 June, the government sent the payment that was due to the bond Trustee, which is based in the United States. The Trustee has not transferred the funds to the bondholders because two restraining notices were issued on behalf of Commissions Import-Export S.A. (Commisimpex, unrated). Commisimpex is a contractor that performed work in ROC in the 1980s through the enterprise 'B timents et Travaux Publics', and has been pursuing payment through decades of litigation in French, English and American courts. The company claims that it is now due EUR1 billion from the ROC government. The government recognises a much smaller claim and has not succeeded in reaching an agreement with the contractor.

The next semi-annual coupon payment on the Eurobond maturing in 2029 is due in December. If the Trustee remains unable to transfer to the bondholders the funds associated with the next coupon payments, the ROC government could remain in default under Moody's definition for a protracted period of time. Ultimately, the capacity of the government to resolve such a default event may be constrained by factors beyond its willingness and financial capacity to pay, as this may also be dependent upon court decisions.

Even if the Trustee transfers the funds to the bondholders in the following weeks or months, there will remain a risk that future coupon payments could be blocked from reaching bondholders as long as the legal dispute between Commisimpex and the ROC government continues.

The government's default on its sole Eurobond will exacerbate liquidity pressures that have been increasingly acute since the oil price shock that began in 2014. Liquidity pressures result from large government financing needs, themselves partly induced by falling oil-derived revenues, and increasingly limited financing options. Today's rating action also reflects Moody's view that these acute liquidity pressures have increased the risk of losses to private sector creditors in the coming years.

Government financing needs, estimated to reach at least 15 per cent of GDP this year, result primarily from the government's large primary deficits in cash terms. Additionally, important downside risks stem from goods and services providers' claims on the government. While there are no comprehensive statistics concerning the latter, estimated total claims that may need to be met or supported by the government could be as large as 30 per cent to 40 per cent of GDP, when considering the amount Commisimpex claims it is owed (13 per cent of GDP) along with other claims on the government and closely-related enterprises such as national oil company Societe Nationale des Petroles du Congo (unrated). This is particularly large compared to the government debt, which, stricto sensu (excluding arrears and other liabilities not accounted for as debt), amounted to 64 per cent of GDP at the end of 2016.

The government's funding options are increasingly limited. The government has nearly exhausted the two financing sources it has extensively relied on since 2014, namely its cash deposits and borrowings from its central bank, the BEAC (Banque des Etats d'Afrique Centrale, unrated). At year-end 2016, the government only had four per cent of GDP in cash deposits at the BEAC, down from 19 per cent as of December 2014. In the absence of an IMF programme, which is uncertain at this time given the country's reluctance to subscribe to such a programme's conditionality, the sovereign has very few viable funding options. The regional capital markets are particularly shallow and access to international markets is unlikely given the credit event now unfolding. Moody's notes however that by far the country's main source of funding is China (A1 stable), although there is limited visibility regarding the availability of credit under the bilateral arrangements between the two countries.

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