These ratings are vital for countries that need to borrow funds internationally – that is almost every nation.

Ethiopia is now downgraded to “CC” from “CCC”.

It had previously been given a “junk bond” status, meaning many pension funds and other institutions could not lend to Ethiopia. The country is close to bankruptcy.

This is what the ratings mean.

  • CCC: currently vulnerable and dependent on favorable economic conditions to meet its commitments
  • CC: highly vulnerable, very speculative bonds
  • C: highly vulnerable, perhaps in bankruptcy or in arrears, but still continuing to pay out on obligations

Fitch Downgrades Ethiopia’s Long-Term Foreign-Currency IDR to ‘CC’

Thu 02 Nov, 2023 – 12:21 ET

Source: Fitch Ratings – Hong Kong – 02 Nov 2023: FitchRatings has downgraded Ethiopia’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) to ‘CC’ from ‘CCC-‘ and affirmed the Long-Term Local-Currency IDR (LTLC) at ‘CCC-‘.

Fitch typically does not assign Outlooks to sovereigns with a rating of ‘CCC+’ or below.

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

Downgrade of LTFC IDR: The downgrade of Ethiopia’s LTFC IDR reflects Fitch’s view that the material decline in external liquidity and significant external financing gaps have increased the likelihood of a default event. The ‘CC’ rating also reflects a probable risk of a default event that may result from the government’s participation in the G20 Common Framework (CF) debt relief initiative, given the mechanism’s guiding principle of comparable treatment for official and private creditors.

Strained External Liquidity: In the absence of a debt treatment that would reduce Ethiopia’s external debt servicing burden and facilitate external financing, the country’s already strained external liquidity will continue to worsen. Fitch estimates sovereign external principal and interest payments at USD1.0 billion in the fiscal year ending 7 July 2024 (FY24) and USD2.0 billion in FY25, with a USD1 billion Eurobond maturing in December 2024.

The non-sovereign public sector also faces about USD1 billion in debt service obligations annually. Official international reserves fell to USD1.0 billion in FY23 (less than one month of current external payments). We expect the next USD33 million Eurobond coupon due in December to be paid.

Structural External Imbalances: Ethiopia runs structural current deficits (CAD) and the external imbalances have worsened in the past three years amid multiple shocks and disrupted external loans. Fitch estimates that the CAD narrowed to 2.9% of GDP (USD4.6 billion) in FY23 from 3.8% in FY22 as import compression partly offset the significant fall in exports.

Depreciation in Ethiopia’s official FX rate against the US dollar was limited at 5% in FY23, compared with annual average depreciation of 18% in FY20-22. However, anecdotal evidence suggests that the parallel market exchange rate premium often exceeds 80%, generating substantial illicit financial flows and informal trading. This suggests room for a sharper adjustment of the official exchange rate.

Little Progress on Common Framework: The official creditor committee convened in September 2021 but has yet to reach any publicly acknowledged agreement on Ethiopia’s debt treatment. Part of the delay has been due to the Tigray conflict and the lack of the necessary debt sustainability analysis. The peace agreement of November 2022 paved the way for IMF negotiations on a financing programme, which together with the disbursements from other multilaterals, could address the financing gaps remaining upon agreement of a CF debt treatment. The IMF mission in October 2023 reported progress on reform discussions but did not reach a staff-level agreement.

Ethiopia is reported to have initiated negotiations with bilateral creditors including China on debt relief outside the CF, but details are not publicly available. Fitch expects bilateral liquidity relief to be insufficient to address the large financing gaps and improve debt sustainability in the medium term, in the absence of renewed financing from international financial institutions. Prolonged delays in securing financing from the IMF and other multilaterals will lead to a further deterioration in external liquidity.

Rising Domestic Financing Cost: The government is increasingly reliant on domestic financing primarily sourced from the banking sector, amid dented external official funding. We forecast interest service to increase to 10.5% of general government revenue in FY24 as the cost of domestic debt issuance rises in line with domestic interest rates (although these are not market-determined) and the initiative to reduce monetary financing. The National Bank of Ethiopia (NBE) issued a directive in November 2022 requiring commercial banks to purchase the new five-year Treasury Bond at 9% interest rate with the amount equivalent to 20% of monthly loans and advance disbursements.

A significant share of domestic debt has been in the form of direct advances from the NBE, reaching ETB120 billion at end-FY23. In addition, the NBE holds sizable government bonds (ETB434 billion or around 38.5% of total domestic debt at end-FY23) that pay low interest, including a stock of ETB200 billion direct advances converted in FY20.

Tight Fiscal Position: Fitch estimates that the general government fiscal deficit narrowed to 2.6% of GDP in FY23 from 3.4% in FY22, as low revenue collection was matched by under-executed expenditure. Fitch estimates that the revenue base declined to 8.4% of GDP in FY23 from an average 12.5% of GDP in FY18-20, reflecting severe constraints in revenue collection capacity exacerbated by distortions in the foreign-exchange market. We expect fiscal deficits to remain sizable at around 3.2% of GDP in FY24-26 owing to low revenue collection and high humanitarian and reconstruction spending.

Vulnerable Debt Profiles: We estimate that deflator effects brought central government debt down to 25.8% of GDP at end-FY23 from 30.3% at end-FY22, valued at official exchange rates. We expect a further decline in the public debt ratio over the medium term, assuming annual depreciation of 15%-20%, but debt/revenue will likely worsen. Even with the addition of approximately 15% of GDP in debt held by SOEs, total public sector debt/GDP is lower than the ‘B’/’C’/’D’ median of 71.7% in 2023.

More than half of government debt is held by external creditors, of which over 90% is held by multilateral and bilateral lenders. This somewhat limits risks to the debt profile, although the metrics are still vulnerable to sharp exchange rate depreciation.

Inflationary Pressures Remain High: Headline inflation averaged 32.5% in FY23 and 28.4% in 1QFY24, reflecting the combination of supply-side shocks, currency weakness and expansionary fiscal and monetary policies, including direct central bank financing of the government. To combat inflation with its limited monetary policy tools, the NBE has decided to cap the growth of bank credit to the private sector at 14% and taper direct advances to one-third of the prior year level. We forecast FY24 average inflation to slow to 25% and the impact of further official exchange rate depreciation would potentially be limited as a sizeable share of imports is already priced at parallel exchange rates.

ESG – Governance and Creditor Rights: Ethiopia has an ESG Relevance Score (RS) of ‘5’ for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Ethiopia has a low WBGI ranking at 21.6, reflecting the absence of a recent track record of peaceful political transitions, relatively weak rights for participation in the political process, weak institutional capacity, uneven application of the rule of law and a high level of corruption.

Ethiopia also has an ESG Relevance Score of ‘5’ for Creditor Rights, as willingness to service and repay debt is highly relevant to the rating, as for all sovereigns. Furthermore, Ethiopia faces an increasing possibility of default, as reflected in the ‘CC’ LTFC IDR.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

– Launch of a formal debt renegotiation by the authorities that Fitch deems to constitute a distressed debt exchange

– Failure to pay debt obligations owed to private creditors or public debt securities, or a unilateral declaration of a debt moratorium.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

– External Finances: Stronger external finances leading to higher foreign-currency reserves, for example, through policy adjustments and/or significant new financing sources that would provide satisfactory confidence that payments on the Eurobond would be timely honoured.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

Fitch’s proprietary SRM assigns Ethiopia a score equivalent to a rating of ‘B-‘ on the LTFC IDR scale. However, in accordance with its rating criteria, Fitch’s sovereign rating committee has not utilised the SRM and QO to explain the ratings in this instance. Ratings of ‘CCC+’ and below are instead guided by the rating definitions.

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.

COUNTRY CEILING

The Country Ceiling for Ethiopia is ‘B-‘. For sovereigns rated ‘CCC+’ and below, Fitch assumes a starting point of ‘CCC+’ for determining the Country Ceiling. Fitch’s Country Ceiling Model produced a starting point uplift of 0 notches above the IDR. Fitch’s rating committee applied a +1 notch qualitative adjustment to the model result, under the Balance and Payments Restrictions pillar, reflecting our view that the private sector has not been prevented or significantly impeded from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.

Fitch does not assign Country Ceilings below ‘CCC+’, and only assigns a Country Ceiling of ‘CCC+’ in the event that transfer and convertibility risk has materialised and is impacting the vast majority of economic sectors and asset classes.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Ethiopia has an ESG Relevance Score of ‘5’ for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Ethiopia has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.

Ethiopia has an ESG Relevance Score of ‘5’ for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Ethiopiahas a percentile rank below 50 for the respective Governance Indicators, this has a negative impact on the credit profile.

Ethiopia has an ESG Relevance Score of ‘5’ for Creditor Rights as willingness to service and repay debt is highly relevant to the rating, as for all sovereigns. Furthermore, Ethiopia faces an increasing possibility of default, as reflected in the ‘CC’ LTFC IDR.

Ethiopia has an ESG Relevance Score of ‘4’for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As Ethiopia has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.

The highest level of ESG credit relevance is a score of ‘3’, unless otherwise disclosed in this section. A score of ‘3’ means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch’s ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.

ENTITY / DEBT  

RATING  

PRIOR  

Ethiopia

LT IDR

CC 

Downgrade

CCC- 

ST IDR

C 

Affirmed

C 

LC LT IDR

CCC- 

Affirmed

CCC- 

LC ST IDR

C 

Affirmed

C 

Country Ceiling

B- 

Affirmed

B- 

  • senior unsecured

LT

CC 

Downgrade

CCC- PREVIOUS

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PARTICIPATION STATUS

The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.

APPLICABLE CRITERIA

APPLICABLE MODELS

Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).

  • Country Ceiling Model, v2.0.0 (1)
  • Debt Dynamics Model, v1.3.2 (1)
  • Macro-Prudential Indicator Model, v1.5.0 (1)
  • Sovereign Rating Model, v3.14.0 (1)

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ENDORSEMENT STATUS

EthiopiaEU Endorsed, UK Endorsed

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The ratings above were solicited and assigned or maintained by Fitch at the request of the rated entity/issuer or a related third party. Any exceptions follow below.

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Fitch’s international credit ratings produced outside the EU or the UK, as the case may be, are endorsed for use by regulated entities within the EU or the UK, respectively, for regulatory purposes, pursuant to the terms of the EU CRA Regulation or the UK Credit Rating Agencies (Amendment etc.) (EU Exit) Regulations 2019, as the case may be. Fitch’s approach to endorsement in the EU and the UK can be found on Fitch’s Regulatory Affairs page on Fitch’s website. The endorsement status of international credit ratings is provided within the entity summary page for each rated entity and in the transaction detail pages for structured finance transactions on the Fitch website. These disclosures are updated on a daily basis.