Moody’s Investors Service (“Moody’s”) has today changed the outlook on the Government of Maldives’ issuer rating to negative from stable and affirmed the B2 issuer and senior unsecured bond ratings.
The decision to change the outlook to negative reflects liquidity and external vulnerability risks stemming from a sharp rise in the government’s debt burden that is expected to extend at least until the beginning of the next decade when a large scale infrastructure program is scheduled to complete.
The government’s liquidity risks reflect limited financing sources, including the domestic banking system and external investors, to meet sizeable gross financing needs required by the infrastructure program, at a time when, according to Moody’s assumptions, the government will continue to need financing for current spending. These risks could rise in the run-up to repayments on a sovereign bond that are due in 2022. In addition, the strain on Maldives’ fragile external position could increase in the next few years, if large imports as part of the investment projects are not fully financed by capital inflows in a timely manner and/or the exchange rate appreciates again in real effective terms.
The decision to affirm the B2 rating is supported by the improvement in growth potential that infrastructure development is likely to bring, balanced by a rising debt burden and declining debt affordability as the Maldives reduces the proportion of concessional funding in its funding mix.
The local-currency bond and deposit ceilings are unchanged at Ba1. The foreign currency bond ceiling is unchanged at Ba3 and the foreign currency deposit ceiling is unchanged at B3.
RATIONALE FOR THE NEGATIVE OUTLOOK
PRESSURE ON GOVERNMENT LIQUIDITY MAY INCREASE IN THE RUN UP TO REPAYMENTS
Largely as a result of its investment program, and ahead of a sizeable debt maturity in 2022, the government’s borrowing needs will rise, albeit from moderate levels. The size of the upcoming borrowing needs depends on future revenue and expenditure, while some financing sources also depend on sustained robust revenue growth, raising risks to the government’s liquidity position if fiscal targets are not achieved.
Moody’s expects the government’s gross borrowing needs will increase to 8.3% of GDP by 2019 from around 7.1% of GDP in 2017. Although needs should remain contained around these levels until 2022, Moody’s estimates that they will rise to 9.1% in that year, when the repayment on the sovereign bond comes due.
In order to meet these needs, the government will likely rely on the domestic banking system to absorb treasury bill issuances, while simultaneously aiming to secure external financing. Prospects for further domestic financing may become constrained if some banks reach internal limits for holding government securities, leading to pressures on refinancing costs.
The availability and cost of external financing will depend on market appetite for Maldives’ bonds, as well as the government’s ability to access consistent sources of bilateral funding. In particular, tighter global liquidity conditions suggest that the Maldives will only be able to access market financing at rates likely to worsen debt affordability.
As mentioned, the rise in borrowing requirements is largely driven by government spending on the Public Sector Infrastructure Program, which includes infrastructure projects that will enhance Maldives’ economic competitiveness, particularly in the tourism sector; improve the basic provision of services, including health, water and sanitation; and facilitate relocation for portions of the population for better service delivery. Infrastructure projects are to cumulatively amount to MVR 33.8 billion ($2.2 billion or around 38% of estimated 2020 GDP) in 2016-2020. In 2016-17, projects worth MVR 12.2 billion were already embarked upon.
Implementation of these infrastructure projects has also required foreign exchange funding, leading to the issuance of $250 million sovereign bond in 2017, and the private placement of a $100 million bond in April 2018, both with five-year maturities.
According to Moody’s, part of the borrowing needs will also be driven by recurrent expenditures, which may not decelerate according to government projections.
One alleviating factor for the government’s liquidity position is the recent creation of a Sovereign Development Fund for repayment of the upcoming debt obligations on the 2017 sovereign bond issuance and other infrastructure-related debt. However, the size of the fund is still small (around 1.6% of GDP estimated in 2018) and its growth will depend on continued robust revenue growth. Historically, revenue collections have been volatile. A one-off negative shock to revenue would leave a gap in the financing sources to repay the sovereign bond in 2022 in particular.
Should liquidity strains intensify, the key policy options available to the government would be to turn to bilateral funding or slow investment spending. However, a weak institutional framework suggests that the speed and effectiveness of the policy response may be limited.
RISKS TO MACROECONOMIC STABILITY FROM EXCHANGE RATE APPRECIATION AND LOW RESERVES ADEQUACY
A marked appreciation of the exchange rate in real effective terms in recent years, wide current account deficits and low reserve adequacy suggest that risks could escalate in the event of a disruption to funding. The fixed exchange rate regime constrains the capacity of the central bank to respond to potentially rising external imbalances.
Current account deficits have averaged about 7% of GDP between 2011-15 and widened significantly in recent years, to 19% of GDP in 2017. These have been primarily financed by foreign direct investment (FDI), and loans (primarily project-related), resulting in an overall accretion to reserves. However, reserve coverage remains low and would not be sufficient to meet imports payment and external debt commitments in the event of delayed FDI flows or an inability to access external financing at affordable costs.
RATIONALE FOR THE RATING AFFIRMATION
At B2, the rating reflects some credit strengths on the economic side, combined with relatively low fiscal strength and latent political risk.
Economic strength stems from an improvement in growth potential that the infrastructure ramp-up is likely to bring. Vulnerability to climate change, including to natural disasters that could have a large impact on economic activity, weighs on Maldives’ economic strength.
On the fiscal side, owing to the infrastructure build-up, the Government of Maldives’ debt burden has increased by about 7 percentage points, to 61.1% of GDP in 2017 from 54.1% in 2015. Moody’s expects it to increase further to 68.7% of GDP by 2020.
A rising proportion of non-concessional funding has led to a deterioration in debt affordability. The ratio of interest payments to revenues stood at 6.3% at end 2017. Pressure on external debt servicing costs is partly offset by the still sizeable proportion of concessional borrowing. But debt affordability metrics would remain under pressure as the government’s market-driven funding needs grow. As of end 2017, foreign currency debt comprised about 38% of total government debt, an increase from about 31% in 2015. This share should continue to increase going forward.
The B2 rating also takes into consideration moderate political risks, arising from potential conflicts that could depress tourism activity, investment and growth.
WHAT COULD CHANGE THE RATING UP
While an upgrade is unlikely in the near term given the negative outlook, we would consider stabilizing the outlook if (1) a more gradual implementation of the infrastructure development program entails a less pronounced increase in the debt burden and funding needs than we presently expect; and/or (2) access to external and domestic funding sources looks increasingly secure and likely to pose less of a strain on debt affordability.
WHAT COULD CHANGE THE RATING DOWN
A rating downgrade would likely result from (1) a more pronounced deterioration in fiscal and debt metrics and debt affordability than we currently expect; (2) marked strains on debt and deficit financing resulting in significantly higher debt costs; and/or (3) a lasting shock to the tourism sector, such as through natural disasters or political events that will ultimately result in a sharp fall in foreign exchange earnings.
GDP per capita (PPP basis, US$): 19,167 (2017 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 7.1% (2017 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 1.3% (2017 Actual)
Gen. Gov. Financial Balance/GDP: -3.1% (2017 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -19% (2017 Actual) (also known as External Balance)
External debt/GDP: 38.0% (2017 Estimate)
Level of economic development: Low level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983
On 23 July 2018, a rating committee was called to discuss the rating of the Maldives, Government of. The main points raised during the discussion were: The issuer’s fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptible to event risks.
The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. 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.
Full details are available at the link below:
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