Fitch upgrades Ethiopia's credit ratings as financial pressures ease

Fitch Ratings has upgraded Ethiopia’s credit rating due to easing financial pressures. In its latest rating note, Fitch upgraded the country’s Long-Term Local-Currency (LTLC) Issuer Default Rating (IDR) to ‘CCC+’ from ‘CCC-‘ and affirmed the Long-Term Foreign-Currency IDR at ‘RD’ (Restricted Default).

The upgrade of Ethiopia’s LTLC IDR to ‘CCC+’ from ‘CCC-‘ reflects easing financing pressures, improved macroeconomic stability, and increased confidence that local-currency obligations will not be included in the ongoing debt restructuring, Fitch said.

It stated that renewed concessional external financing has significantly reduced net domestic financing requirement. Ethiopia aims to phase out non-market-based local financing of fiscal deficits to reduce financial repression and contain inflation.

The National Bank of Ethiopia (NBE) introduced market-based determination of the exchange rate on 29 July 2024, leading to over 50% depreciation of the official rate, closing the gap with the parallel market exchange rate.

The NBE eased a number of foreign-exchange (FX) restrictions, eliminating the rationing of FX for importers and increasing FX retention. The NBE also introduced an interest-rate based monetary policy regime, setting the initial policy rate at 15%, and started conducting regular open market operations to enhance monetary policy transmission.

The IMF approved a new four-year Extended Credit Facility Arrangement for Ethiopia on 29 July 2024, with an immediate disbursement of USD1 billion from a total USD3.4 billion funding.

This arrangement, together with expected disbursements from the World Bank (totaling USD3.75 billion), will help reduce reliance on domestic financing.

“We estimate net domestic borrowing to decline to 0.5% of GDP in the fiscal year ending in June 2025 (FY25) and 1.3% in FY26, from 2.1% in FY23 and 1.7% in FY24”.

Fitch estimates that the general government fiscal deficit narrowed to 2% of GDP in FY24 from 2.5% of GDP in FY23. The ratings agency also projects the fiscal deficit will rise to 2.7% of GDP in FY25, due to windfall revenue gains from easing FX distortions being more than offset by increased spending, including a 1.5% of GDP fiscal package for the vulnerable and public sector wage increases.

Interest expenditure is projected to rise to 1.2% of GDP from a low 0.6% of GDP in previous years. It said the NBE has started market-based auctions of Treasury bills to address domestic financing needs. “We anticipate that government borrowing costs will rise to positive real interest rates in the medium term, increasing rollover risks”.

All NBE’s direct advances totaling ETB242 billion at the end of FY24 have been converted to long-term government securities and the mandatory purchase of treasury bond by commercial banks will be phased out in FY25.

The government issued ETB266 billion of long-term bonds in exchange for treasury bills held by pension funds.

“We did not view the exercise as a distressed exchange designed to avoid a traditional payment default because the government had no difficulty rolling over the treasury bills at prevailing yields of 9-10%, and the pension funds remain main buyers of newly-issued treasury bills”, Fitch said.

Ethiopia remains in default on its foreign-currency debt obligations since suspending payments on its single outstanding USD1 billion Eurobond in December 2023.

The country has since made progress on its external debt restructuring under the Common Framework, which involves a restructuring of both its official bilateral and commercial external debt, on comparable terms, although the timing of completion is still uncertain.

Ethiopia is looking to restructure about USD15.1 billion of external debt (including arrears, as of end-June 2024) under the Common Framework, for which it applied in 2021.

An interim debt standstill was agreed upon with the official creditor committee (OCC) and major Chinese creditors in November 2023, suspending bilateral debt service for 2023 and 2024, representing USD1.3 billion of net relief.

“We expect Ethiopia will reach an agreement with the OCC on the terms of the official debt treatment by the end of 2024, succeeding the interim standstill”.

Ethiopia is then expected to negotiate debt treatment with commercial creditors on comparable terms. Commercial creditors hold around 10% of Ethiopia’s total public and publicly guaranteed external debt totaling USD30.9 billion as of end-June 2024, including the USD1 billion Eurobond that was to mature in December 2024.

Official international reserves, barely above USD1 billion in FY24, are expected to increase to USD2.9 billion in FY25 and USD4.5 billion in FY26 thanks in part to rising multilateral disbursements.

This would represent 1.8 months of current external payments in FY26 based on our forecasts, although this will depend on the final terms of the external debt restructuring. The alignment of official and parallel market exchange rates also boosts gold exports and replenishes official international reserves.