Pandemic shock exacerbated Ghana’s already-weak public finances – Fitch

Fitch Ratings has noted that the shock experienced by Ghana’s economy following the outbreak of the coronavirus pandemic has worsened the already-weak public finances of the oil-producing West African nation.

The American credit rating agency said in its latest report that it forecasts the increased expenditure contained in the revised budget and lower tax revenue to bring the fiscal deficit to 10.5% of GDP on a commitment basis, more than twice the 2019 commitment basis deficit of 4.7%.

“The pandemic shock has exacerbated Ghana’s already-weak public finances. The government presented a revised 2020 budget in July as part of its Mid-Year Budget Review (MYBR), which contained an additional GHS11 billion (3% of forecast 2020 GDP) in COVID-related expenditure.

“It also forecast domestic financing costs to rise by approximately 2% of GDP. The revised budget was approved by Parliament along with the government’s request to suspend the fiscal rules contained in the Fiscal Responsibility Act of 2018, which includes a fiscal deficit ceiling of 5% of GDP.

“We forecast the increased expenditure contained in the revised budget and lower tax revenue to bring the fiscal deficit to 10.5% of GDP on a commitment basis, more than twice the 2019 commitment basis deficit of 4.7%. The government had brought the commitment basis deficit to below 5.0% in 2017-2019, following the 2016 election-year blowout. Cash deficits remained high as the government paid down domestic arrears and realised the cost of contingent liabilities in the banking and energy sectors.

“The cost of bank recapitalisation added an estimated GHS18 billion (5.5% of 2020 GDP) to cash deficits over 2018-2020. Clearing arrears in the energy sector added 1.6% of GDP to the 2019 deficit and we assume it will add an additional 1.0% a year through 2023. We expect the 2020 cash deficit to be 13.6% of GDP.”

Below is the full report:

Fitch Ratings has affirmed Ghana’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘B’ with a Stable Outlook.

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

KEY RATING DRIVERS

The affirmation reflects Fitch’s expectation of a gradual recovery in economic performance and fiscal revenue following the coronavirus pandemic shock, a stabilisation of debt/GDP and the ready availability of external and domestic financing sources. This is balanced against the risk that post-election fiscal slippages or a weaker economic recovery will worsen fiscal and external debt metrics.

The pandemic has affected Ghana’s domestic economy through lockdowns on its two biggest cities and the related global shock has impacted trade and financial flows. The largest impact was likely to have been felt in 2Q20, but at -3.2% yoy, the contraction in GDP was less than we had anticipated.

The mining sector, which includes oil and gas, and manufacturing experienced the steepest contraction, while agriculture, construction and transport recorded positive growth.

We forecast 2020 growth at 2.0%, returning to 5.0% by 2022, although low global oil prices will inhibit investment in Ghana’s oil infrastructure and could weigh on medium-term growth. The oil sector had been a major growth contributor over 2017-2019.

Inflation accelerated to over 11.0% in May, but has slowed in recent months. Fitch forecasts 2020 average inflation at 9.7%, well above the forecast ‘B’ median of 4.5%, but lower than Ghana’s five-year average of 12.9%.

The pandemic shock has exacerbated Ghana’s already-weak public finances. The government presented a revised 2020 budget in July as part of its Mid-Year Budget Review (MYBR), which contained an additional GHS11 billion (3% of forecast 2020 GDP) in COVID-related expenditure.

It also forecast domestic financing costs to rise by approximately 2% of GDP. The revised budget was approved by Parliament along with the government’s request to suspend the fiscal rules contained in the Fiscal Responsibility Act of 2018, which includes a fiscal deficit ceiling of 5% of GDP.

We forecast the increased expenditure contained in the revised budget and lower tax revenue to bring the fiscal deficit to 10.5% of GDP on a commitment basis, more than twice the 2019 commitment basis deficit of 4.7%. The government had brought the commitment basis deficit to below 5.0% in 2017-2019, following the 2016 election-year blowout.

Cash deficits remained high as the government paid down domestic arrears and realised the cost of contingent liabilities in the banking and energy sectors.

The cost of bank recapitalisation added an estimated GHS18 billion (5.5% of 2020 GDP) to cash deficits over 2018-2020. Clearing arrears in the energy sector added 1.6% of GDP to the 2019 deficit and we assume it will add an additional 1.0% a year through 2023. We expect the 2020 cash deficit to be 13.6% of GDP.

We forecast the cash deficit to narrow to 7.1% of GDP in 2021 and to 6.0% in 2022, but a failure to consolidate following the December 2020 presidential election is a key risk to our projections.

Such risks were illustrated by the MYBR and the 2021-2024 Budget Preparation Guide, released in August 2020; both indicate a very gradual path to deficit reduction following 2020’s fiscal expansion, but Fitch believes that only after the election will there be more clarity around the medium-term fiscal framework.

Fitch’s baseline fiscal scenario assumes that the government continues to under-execute its capital budget and that most of the COVID-related expenditure is removed from the budget by 2022, while revenue returns to pre-2020 levels.

Evidence that Ghana’s post-election fiscal strategy would lead to a higher public-debt trajectory could be a source of downward pressure on the ratings. Furthermore, the election itself brings additional risk in the form of off-budget spending or the building of domestic arrears, which has led to fiscal crises in previous electoral cycles.

Fitch believes that Ghana’s liquidity and available financing sources are consistent with the ‘B’ rating. We estimate the government’s 2020 total fiscal financing and debt amortisation needs at approximately USD10.9 billion (16% of GDP).

Ghana raised USD3 billion through Eurobond issuance in February. The government will also receive USD1.5 billion from the IMF and other official creditors in budget support and approximately USD700 million in project loans for the externally financed portion of capital expenditure. It will also draw down a total of USD210 million from the Ghana Petroleum Funds and may draw additional funds from their combined oil savings accounts.

Increased pandemic-related expenditure will largely be financed domestically. The authorities approved a Bank of Ghana (BoG) asset-purchase programme, which allows for up to GHS10 billion cedi (USD1.8 billion) in direct placement with the central bank. The government will meet the remainder of its domestic financing needs from local debt markets.

We note that the share of non-resident investment in domestic government debt has fallen to 20%, from a high of just below 40% in 1H18, although 20% is closer to the historical average. The government has been able to replace some of the non-resident investment with investment from Ghana’s pension funds and other non-bank financial institutions.

The suspension of the Fiscal Responsibility Act was accompanied by the triggering of an emergency clause in the existing BoG legislation that would allow the central bank to breach the 5% ceiling of the previous year’s revenue in direct financing of the government.

In our view, liquidity pressure may increase in 2021, partly because risks associated with the central bank’s deficit financing will increase if sustained at a high level. The government, on average, borrowed GHS1.3 billion (slightly more than 1% of GDP) from the BoG annually in 2011-2016, which allowed for greater fiscal deficits and contributed to higher inflation through the fiscal dominance of monetary policy.

We forecast debt at 72.8% of GDP by end-2020, which includes the outstanding stock of GHS7.6 billion (2.1% of GDP) in Energy Sector Levy Act bonds. We expect debt to continue rising through 2022, although at a slower pace.

However, the failure to execute planned reforms in energy sector would see a continued build-up of arrears and higher debt. The government’s 2019 Energy Sector Recovery Program indicated that sector arrears could reach as much as USD12.5 billion (18% of 2020 GDP) by 2023.

Ghana’s high debt-service burden weighs on its rating. Its 2020 debt/GDP ratio is slightly higher than our forecast ‘B’ median of 67.3%. However, we forecast that government debt will reach 530% of revenue, much higher than the 336% ‘B’ median.

Furthermore, interest expense is set to reach 49% of government revenue in 2020, four times the ‘B’ median of 12%. Ghana’s interest payments will rise in 2020 following greater reliance on the domestic debt market, where interest rates are higher than for foreign-currency debt.

Ghana remains somewhat reliant on Eurobond flows and other international borrowing to bolster international reserves, but external pressure has been less than we expected. The cedi, supported by limited BoG forward auctions, has depreciated by 3% year-to-date, compared with an average depreciation rate of 12% in the 10 years to 2019. Robust gold exports and some import compression have kept the trade balance in surplus.

Fitch forecasts the current account deficit to widen modestly to 3.9% of GDP from 2.8% in 2019. We expect gross reserves to end 2020 at USD6.6 billion, broadly the same as in December 2019, as some foreign-exchange intervention by the BoG to support the currency is offset by new inflow from debt and 4Q cocoa receipts. The import compression will slightly improve reserve coverage to 2.8 months of current external payments, from 2.7 in 2019.

Ghana’s banks are stronger following the BoG-led Financial Sector Clean Up and Recapitalisation, which raised minimum capital requirements and forced sector consolidation.

Capitalisation and liquidity have improved, but economic headwinds will delay substantial improvement in asset quality. Non-performing loans/total loans fell to 14% in 2019, from 22% two years prior, but the ratio will remain high as private-sector credit growth slows in 2020. We expect real private-sector credit growth to remain positive in 2020, but in the low single digits.

ESG – Governance: Ghana has an ESG Relevance Score of 5 for both Political Stability and Rights and Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns.

Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Ghana has a medium WBGI ranking at the 53rd percentile, reflecting a recent record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to positive rating action/upgrade are:

– Public Finances: Greater confidence in the government’s ability to move public debt/GDP onto a downward path, for example, through the implementation of a credible post-pandemic fiscal consolidation strategy.

– External Finances: An improvement in Ghana’s external liquidity, such as an increase in international reserves occurring through non-debt-creating flows.

The main factors that could, individually or collectively, lead to negative rating action/downgrade:

– Public Finances: Expectations of a persistent rise in the medium-term public debt trajectory resulting, for example, from a lack of a credible consolidation strategy following the 2020 election.

– External Finances: A decline in international reserves, for example, as a result of a prolonged lack of access to international capital markets.

– Macro: A deeper near-term macroeconomic shock or a sustained increase in macroeconomic instability, for example, due to subsequent waves of pandemic-related measures and/or prolonged fiscal slippage.

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

Fitch’s proprietary SRM assigns Ghana a score equivalent to a rating of ‘B+’ on the Long-Term Foreign-Currency IDR scale.

Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows:

– Public Finances: -1 notch, to reflect high government debt and interest burden relative to revenue and an uncertain level of contingent liabilities to the sovereign from the energy sector.

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 Long-Term Foreign-Currency 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.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years.

The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].

KEY ASSUMPTIONS

Fitch expects global indicators, including oil prices, to move in line with Fitch’s Global Economic Outlook forecasts.