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Press release by Fitch Ratings
November 27, 2018 -- Fitch Ratings has downgraded Nicaragua's long-term foreign-currency issuer default rating (IDR) to 'B-' from 'B'. The outlook is 'negative'.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The downgrade and negative outlook reflect a bigger than expected economic contraction, a growing fiscal deficit, weaker external liquidity and heightened risks of domestic and external financing constraints. Although the level of violence has subsided since Fitch's last review in June, the risk of political instability remains high and undermines prospects for an economic recovery. Dialogue between the government and the opposition made little progress, and the government is subject to growing international pressure over its handling of recent political protests.
Political demonstrations on April 19, 2018 were followed by about three months in which roadblocks set by the opposition reduced traffic nationwide substantially, including within the capital Managua. The government forcibly removed the roadblocks and regained control of the territory. International observers estimate the death toll from the unrest at about 400 people, with a similar number imprisoned.
Fitch estimates that in 2018 and 2019 the economy will contract by 4% and 1%, respectively, in line with recent IMF forecasts, a steeper contraction than estimated at our last review in June. The economy shrank by 4.4% yoy in 2Q18 due to falls in consumption and capital investment. While the most intense part of the contraction has passed, the fallout will linger. For example, the Nicaraguan chamber of tourism estimates a near halving of tourism revenues in 2018 from US$840mn (11% of CXR) in 2017.
The economic contraction has pressured public finances. Fitch projects that central government revenue/GDP will fall by 1.6pp in 2018 due to lower activity and weaker tax compliance. The government reacted to the fall in revenue by revising the 2018 budget to cut expenses by 1.4% of GDP, substituting external for local financing and widened the deficit target to 2.1% of GDP from a budgeted 0.6%.
The social security institute (INSS) deficit continues to grow. Fitch forecasts that in 2018 the deficit will be 1.1% of GDP from 0.6% in 2017 and will worsen in the absence of a parametric reform. The government has tabled a package of reforms but it is not clear they can be implemented in the current climate. Reforms to the INSS were the trigger for the political unrest in April.
The general government (GG) deficit is projected to more than double in 2018 to 3.2% of GDP from 1.4% in 2017, still better than the 'B' median of 3.9%. GG debt is forecast to rise to 46.8% of GDP at end-2018, in line with the 'B' median. 89% of the GG debt is denominated in foreign currency or indexed to a foreign currency (mostly the US dollar) posing FX risks to debt dynamics.
Flexibility to finance higher deficits is relatively limited, and borrowing is becoming more expensive. Financing is switching from external grants and concessional loans to local capital markets. It is unclear how much new issuance the shallow local capital market can absorb. According to the revised 2018 budget the government plans to issue bonds worth 2.9% of GDP locally and the 2019 budget calls for a further 2.5% of GDP. Average local issuance between 2013 and 2017 was 1.1% of GDP. Local bonds are typically indexed to the US dollar and payable in cordobas (currently the bonds yield 8%). On Sept. 25 the government issued local bonds denominated and payable in euros for EUR105mn (0.9% of GDP) with a seven-year maturity.
Fitch projects that GG net external financing will fall by 60% yoy in 2018. External loan disbursements could be further reduced in view of political pressure especially if the Nicaragua Human Rights and Anticorruption Act passes the US congress. The legislation would impose targeted sanctions on Nicaraguan government officials (the U.S. has already sanctioned four high-ranking officials under the Global Magnitsky Act) and would make the U.S. government use its influence to restrict multilateral lending to Nicaragua. The legislation includes an exception for projects that ensure basic human needs which could limit its impact. The bill was approved by the US senate foreign relations committee on Sept. 26.
A fall in deposits at local banks has translated into a credit crunch. Between March and September of this year bank deposits fell by 21%, although outflows have slowed since early September. The BCN promptly injected liquidity into the market and banks have been able to maintain an adequate level of liquidity coverage. However, between March and September net credit fell by 7.2%. This reduction in credit could be further exacerbated by crowding out as the GG increases local borrowing.
External liquidity has deteriorated although the pace of decline has moderated in line with a slowdown in the pace of bank deposit withdrawals. Between March and September international reserves fell by US$590mn (20%), despite the BCN drawing on a US$200mn credit line from BCIE. Fitch expects the level of reserves (US$2.302bn or 3.3 months of CXP as of September) to stabilize in Q4, below the 'B' median of 3.9 months of CXP. Risks to external liquidity are to the downside given the reduction in FDI, the decline in external financing and the volatile political environment. Reserve coverage of the monetary base is adequate, but Nicaragua is particularly sensitive to its reserve level given its crawling peg (5% annual devaluation with respect to the dollar) and high level of dollarization (89% of credit as of September).
Pressure on external finances has concentrated on the capital account, although there has also been some deterioration on the current account. In 1H18 net FDI contracted by US$126mn (23%) yoy. Fitch projects that in 2018 net FDI will be 3.2% of GDP, down from 5.9% in 2017. On the current account, remittances increased by US$60mn (9.1%) yoy in 1H18 (remittances were 10% of GDP in 2017). Fitch expects an increase in the current account deficit to 6.2% of GDP in 2018 from 5% in 2017 caused by lower tourism receipts and higher oil prices; this compares unfavorably with the 'B' median of 4.2%.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Nicaragua a score equivalent to a rating of 'B-' on the long-term foreign-currency (LT FC) IDR scale.
Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR.
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.
The Outlook is Negative. Future developments that could result, individually or collectively, in a downgrade include:
--An inability to access external or local sources of financing or evidence of heightened risks in meeting debt-service payments.
--A reduction in external liquidity that forces a disorderly adjustment to the exchange rate regime.
Future developments that could, individually or collectively, result in the Outlook being revised to Stable include:
--Reduction of the risks of government access to external and domestic financing.
--Stabilization of the political environment and a recovery of financial, investment, and economic conditions;
--Fitch assumes the global economy and international oil prices perform in line with our Global Economic Outlook.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR downgraded to 'B-' from 'B'; Outlook Negative
Long-Term Local-Currency IDR downgraded to 'B-' from 'B'; Outlook Negative
Short-Term Foreign-Currency IDR affirmed at 'B'
Short-Term Local-Currency IDR affirmed at 'B'
Country Ceiling downgraded to 'B-' from 'B'