Fitch Downgrades Seychelles to 'B+'; Outlook Stable

May 06, 2020

Fitch Ratings - London - 06 May 2020: Fitch Ratings has downgraded Seychelles Long-Term Foreign-Currency Issuer Default Rating (IDR) by two notches to 'B+' from 'BB', with a Stable Outlook.

Under EU credit rating agency (CRA) regulation, the publication of sovereign reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations. Fitch interprets this provision as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status. The next scheduled review date for Fitch's sovereign rating on Seychelles will be 19 June 2020, but Fitch believes that developments in the country warrant such a deviation from the calendar and our rationale for this is laid out below.

KEY RATING DRIVERS

The downgrade of Seychelles IDRs reflects the following key rating drivers and their relative weights:

HIGH

Fitch forecasts the Seychelles' economy will contract by 14% this year, mainly due to the hit to tourism (which directly accounts for an estimated 25% of GDP or around 55% if indirect factors are included). Some support is provided by a sizeable fiscal stimulus package, a 100bp cut in the policy interest rate to 4%, and the fisheries sector (which accounts for 5% of GDP) where canned tuna exports have continued. We project GDP grows 7% in 2021, driven by a partial recovery in tourism from 3Q20, and resumption of FDI and public investment spending. There are sizeable downside risks to our forecasts should the COVID-19 pandemic not be contained in 2H20 in line with Fitch's current baseline assumption.

The fiscal balance is set to deteriorate, from a surplus of 0.2% of GDP in 2019 to a forecast deficit of 15.1% of GDP in 2020, the second largest in the 'B' rating category. The government's amended budget assumes a 50% fall in tourism receipts and 20% reduction in tax revenues, and incorporates measures to postpone taxes due to September, support salaries up to SCR30,000 for three months, and boost health and welfare spending. Fitch forecasts the general government deficit narrows to 6.7% of GDP in 2021 in line with the recovering economy and unwinding of stimulus measures, which compares with the projected 'B' category median of 5.3% of GDP. The large share of migrant workers (almost half the workforce) will help limit the increase in unemployment and cost of further support in 2021.

Fitch forecasts general government debt rises to 79.2% of GDP at end-2020, from 50.5% at end-2019, 30pp higher than we forecast at our last review in December and above the 'B' median of 60.1% of GDP. We exclude debt issued for monetary purposes (8.6% of GDP) as these treasury bills are fully backed by deposits at the Central Bank. Debt is projected to fall to 77.5% in 2021 reflecting a denominator effect as GDP recovers. The government plans to finance this year's deficit through IFI budget support totalling USD70 million (5.7% of projected GDP), domestic bond issuance (with maturities of three, five and seven years) totalling around SCR1.5 billion (7.2% of GDP), T-Bills of SCR0.9 billion, and Central Bank 0% interest advances of SCR0.5 billion. Fitch also assumes a SCR150 million drawdown of government deposits, to 2.3% of projected GDP.

The crisis increases the risks of crystallisation of contingent liabilities. We estimate overall contingent liabilities at close to 15% of GDP, mostly owed by Air Seychelles. The budget allocates 1.1% of projected GDP to Air Seychelles, as well as a 2.4% of GDP guarantee of preference shares to Etihad (which has a 40% ownership). Our public debt projections incorporate further state support of 3.5% of GDP in 2020-2021, equivalent to around 60% of the USD71.5 million 'project box' bond owned to Ethiad, which is due to be rolled over in the next 18 months and is currently being restructured, with a sizeable further downside risk.

The coronavirus shock markedly increases external financing risks. Fitch forecasts the current account deficit widens from 16.8% of GDP in 2019 to 26.5% in 2020, the highest in the 'B' peer group (although statistical underreporting of tourist receipts likely overstates the deficit). The hit to tourism, which accounted for 76% of FX receipts in 2019, will be partly offset from sharp import compression. Linked to this, we anticipate a large reduction in net FDI inflows, which mainly relate to the tourism sector, to 5.3% of GDP in 2020 (around a third of which is equity) from 14.6% of GDP in 2019. We project a narrowing of the current account deficit in 2021 to 20.8% of GDP, and a recovery in net FDI to 13.8% of GDP, driven by a pick-up in tourism.

There is greater uncertainty over external financing sources, with planned net IFI financing only covering around one-fifth of the current account deficit plus FDI in 2020. Fitch forecasts FX-reserves fall from USD581 million at end-2019 to USD388 million at end-2020. Net external debt is set to rise sharply, from 33% of GDP this year to a forecast 68% of GDP, on the back of the fall in nominal GDP, new IFI borrowing, drawdown in private sector assets, and depreciation of the Seychellois rupee, which has fallen 24% against the US dollar since early April. We forecast a smaller reduction in nominal FX reserves in 2021, to USD349 million (2.4 months of current external payments, which compares with the projected 'B' median of 3.7 months) and an increase in net external debt to 72% of GDP (well above the peer group median of 36%).

There is significant external financing available to Seychelles. The 2020 budget includes USD70 million from the IMF (Rapid Financing Instrument COVID-19 facility), World Bank and African Development Bank. A further USD35 million is likely to be available in 2020/2021, which could increase to closer to USD80 million depending on the outcome of IFI proposals to expand lending capacity. This compares with existing external debt service totalling USD103 million in 2020-2021 (54% of which is private sector). Fitch considers the government would also likely be able to negotiate a new funded IMF programme if it chose to do so, given its strong track record of adherence to previous programmes including the Policy Coordination Instrument that expires this year. There is no planned external issuance given market conditions, nor sizeable bilateral support.

Seychelles 'B+' IDRs also reflect the following key rating drivers:

Seychelles' GDP per capita, governance, and human development indicators are much higher than the peer group medians, and there was a strong track record of stable fiscal balances coming into this crisis (averaging 0.2% of GDP surplus in 2015-2019). Set against these factors are Seychelles' small and undiversified economy, structural current account deficit, high external debt, volatile GDP growth and vulnerability to external shocks.

Steady economic reform and general compliance with IMF benchmarks over an extended period (the first Extended Fund Facility was signed in 2009) underpin our expectation of a post-coronavirus fiscal adjustment. The cohabitation between the presidency and the opposition-led National Assembly has not caused political gridlocks. The forthcoming presidential election, currently scheduled in 4Q20, gives rise to somewhat greater policy uncertainty, but Fitch does not expect a marked shift in the reform strategy or macroeconomic management credibility of the next government.

The banking sector enters the crisis well capitalised and profitable, providing a buffer to absorb the expected deterioration in asset quality. The sector Tier 1 capital ratio was 16.5% in February, the return on assets has increased to 3.1%, and the NPL ratio has been low and relatively stable at 3.0% although is set to rise markedly this year. The government has progressed work towards a Financial Stability Act, which would help strengthen macro-prudential policy. There continues to be a risk of loss of correspondent banking relationships due to anti-money laundering concerns with associated reputational costs for Seychelles, which France included in its tax haven blacklist in December. The government is strengthening policy in this area through the enactment in March of AML and Beneficial Ownership legislation and technical assistance from the World Bank.

ESG - Governance: Seychelles has an ESG Relevance Score of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Seychelles has a medium WBGI ranking at the 63rd percentile, reflecting a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.

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

Fitch's proprietary SRM assigns Seychelles a score equivalent to a rating of 'BB' on the LTFC IDR scale, one notch lower than the 'BB+' SRM score at our previous review.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

- External finances: -1 notch to reflect the Seychelles' high gross and net external debt, large and persistent current account deficits, and very high dependence on tourism and fisheries for FX, leaving it exposed to further shocks.

- Macroeconomic performance, policies and prospects: -1 notch to reflect the volatility of GDP growth, limited policy options to cushion the impact of the coronavirus shock, and an expected further negative impact on the SRM score.

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.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- A reduction in external vulnerabilities, for example from a sustainable narrowing of the current account deficit net of FDI driven by a solid recovery in the tourism sector, supporting a higher reserve coverage ratio and reduction in net external indebtedness over the medium term.

- General government debt/GDP returning to a firm downward path over the medium-term, for example due to a sustained recovery in economic growth and a post-coronavirus-shock fiscal consolidation.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- More acute balance of payment pressures leading to a larger fall in foreign-exchange reserves and higher external debt ratios.

- More sharply rising GGGD/GDP, for example due to a more severe or prolonged recession, greater structural fiscal loosening, or additional crystallisation of contingent liabilities.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Public Finance 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 assumes that the global economy develops in line with our Global Economic Outlook published on 22 April, including that the price of Brent crude averages USD35/barrel in 2020 and USD45/barrel in 2021.

- We assume that the global tourism industry experiences a gradual recovery from 3Q20 extending into 2021 after the initial, sharp shock from the coronavirus pandemic this year.

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

Seychelles 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 highly relevant to the rating and a key rating driver with a high weight.

Seychelles 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.

Seychelles has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as strong social stability and voice and accountability are reflected in the World Bank Governance Indicators that have the highest weight in the SRM. They are relevant to the rating and a rating driver.

Seychelles has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Seychelles, as for all sovereigns.

Seychelles has an ESG Relevance Score of 4 for Human Development, Health and Education as managing the impact of the coronavirus crisis is having an adverse impact on the economy, which is relevant to the rating and a rating driver.

Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

RATING ACTIONS

Additional information is available on www.fitchratings.com 

APPLICABLE CRITERIA

Country Ceilings Criteria (pub. 05 Jul 2019)

Sovereign Rating Criteria (pub. 27 Apr 2020) (including rating assumption sensitivity)

APPLICABLE MODELS

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

Country Ceiling Model, v1.7.1 (1)

Debt Dynamics Model, v1.2.0 (1)

Macro-Prudential Indicator Model, v1.4.0 (1)

Sovereign Rating Model, v3.12.0 (1)

ADDITIONAL DISCLOSURES

Dodd-Frank Rating Information Disclosure Form

Solicitation Status

Endorsement Policy

ENDORSEMENT STATUS

SeychellesEU Issued

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SOLICITATION STATUS

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

ENDORSEMENT POLICY

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END 

Source: https://www.fitchratings.com/research/sovereigns/fitch-downgrades-seychelles-to-b-outlook-stable-06-05-2020

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