Ethiopia’s reforms set to accelerate debt restructuring – Fitch

Following approval of a new program by the International Monetary Fund (IMF) for Ethiopia, Fitch Ratings has said the country’s debt restructuring price is set to accelerate.

The global ratings agency said the restructuring followed the government’s introduction of macroeconomic reforms, including exchange rate liberalization and the establishment of a new interest-rate based monetary policy framework.

“We believe debt treatment discussions could progress relatively quickly compared with other recent restructurings under the G20’s Common Framework”.

Ethiopia runs structural current-account deficits and its external imbalances worsened in the past four years amid multiple shocks (both external and internal) and disrupted external financing inflows.

“We believe the country’s strained external liquidity position contributed to the authorities’ suspension of coupon payments on its outstanding USD1 billion Eurobond, which prompted our downgrade of the sovereign’s Long-Term Foreign-Currency Issuer Default Rating (LTFC IDR) to ‘RD’ (Restricted Default), from ‘C’, in December 2023”.

Fitch said between end-2023 and 26 July, the official exchange rate depreciated by less than 3%. The National Bank of Ethiopia (NBE) indicates it fell by a further 24% on 29 July after the reform, narrowing the disparity with the unofficial exchange rate.

Liberalisation may create a near-term inflationary shock as import prices rise, but the IMF program envisages a fiscal package of 1.5% of GDP to mitigate the impact.

“We believe a market-clearing exchange rate that alleviates foreign-currency shortages and structural external imbalances should facilitate private-sector investment and economic growth”.

The new monetary policy regime aims to reduce financial repression and enhance monetary policy transmission.

The authorities had previously relied on administrative measures to control private credit growth, as well as mandatory purchase requirements and NBE advances to address domestic financing needs. Inflation stood at 22% year on year in Q2-2024, against an average of 30% in 2023.

The IMF Executive Board’s approval of Ethiopia’s Extended Credit Facility on 29 July allowed immediate disbursement of USD1 billion of the program’s total USD3.4 billion funding. The IMF projects a financing gap of USD10.7 billion, excluding suspended bilateral debt service due in 2023 and 2024.

This is expected to be addressed through the IMF disbursements, prospective budget support from the World Bank amounting to USD3.75 billion, and debt restructuring of USD3.5 billion during the program period from FY24/25 to FY27/28.

According to the IMF, further debt relief beyond the program period is required to bring Ethiopia’s external debt burden indicators below the thresholds for “moderate” risk of debt distress.

Fitch estimates that debt restructuring of USD3.5 billion would reduce the present value of Ethiopia’s debt-to-exports ratio to 154% by the end of the program period, still above the relevant 140% threshold.

According to the IMF, the common understanding on debt relief required to restore debt sustainability formed by the Official Creditor Committee (OCC) facilitated the swift release of funds under the IMF’s new ‘credible official creditor process’, which reduces formal requirements for release of financing to sovereigns in default, launched earlier this year.

“We expect Ethiopia to reach agreement on treatment of its official debt relatively quickly, as prolonged negotiations with the OCC should already have laid the groundwork”, Fitch said.

The ratings agency noted that the standstill agreement with bilateral creditors in 2023 will be succeeded by a full debt treatment. This would pave the way for talks on restructuring its commercial debt on comparable terms.

Private creditors hold only around 5% of total central government external debt, with over 90% being the USD1 billion Eurobond. This may reduce the complexity of these discussions.

“Once we assess that Ethiopia has completed that restructuring process and normalised relations with a significant majority of its foreign-currency creditors, we would assign a LTFC IDR based on a forward-looking assessment of the sovereign’s willingness and capacity to honour its foreign-currency debt obligations”, Fitch stated.