NEB Research Team
On 11 August 2017, Moody’s downgraded Namibia’s foreign currency issuer default rating (IDR) to Ba1 with a negative outlook citing; Erosion of Namibia’s fiscal strength due to sizeable fiscal imbalances and an increasing debt burden; Limited institutional capacity to manage shocks and address long-term structural fiscal rigidities; and
Risk of renewed government liquidity pressures in the coming years.
On 13th of June 2016, before the downgrade, we published a note titled “SA ratings scrutiny to intensify……can we hold our ground?” pointing to the risks for the Namibian economy as emerging market sovereign ratings faced an onslaught of downgrades. Subsequently we published a note titled “On The Downgrading Of Namibia’s Sovereign Issuances” which was aimed at discussing: Reasons advanced for the downgrade; Tenability of the reasons; How did we fall into this predicament?; The necessary mechanisms for crawling out of this situation; and The imperatives of tracking one’s health indicators.
It was a matter of necessity, that we understood the thinking and methodology of Moody’s at the time of the downgrade, thus this note seeks to shed some light on the methodology, equip stakeholders with deeper insight into the rating agency’s mindset and present recommendations towards transitioning back into investment grade territory.
Moody’s assessment of sovereign credit risk is based on the interplay of four key factors: Economic Strength, Institutional Strength, Fiscal Strength, and Susceptibility to Event Risk.
The information used in assessing the sub-factors is generally drawn from a number of international sources, including the International Monetary Fund, the Organization for Economic Cooperation and Development, the European Commission, the World Bank, WEF and the Bank for International Settlements. Some indicators, however, particularly in the area of government and external debt, require estimation by Moody’s analysts based on data provided by national statistical sources.
Factors 1 and 2, Economic Strength and Institutional Strength combine into a construct designated as Economic Resiliency. An aggregation function then combines Economic Resiliency (ER) and Factor 3 (Fiscal Strength, or FS), as illustrated by Exhibit 1: the weight of Fiscal Strength is highest for countries with moderate Economic Resiliency. The combination of these three factors results in a preliminary, indicative alpha-numeric range for government financial strength rating. As a final step, a country’s Susceptibility to Event Risk (Factor 4) is a constraint which can only lower the preliminary alpha-numeric range that results from combining the first three factors.
The first factor considered was the country’s Economic Strength. The intrinsic strength of the economy, focusing on growth potential, diversification, competitiveness, national income, and scale is important in determining a country’s resilience or shock-absorption capacity. A sovereign’s relative ability to generate revenue and service debt over the medium term relies on fostering economic growth and prosperity.
The second factor that was considered is whether our institutional features are conducive to supporting government’s ability and willingness to repay its debt. A related aspect of Institutional Strength is the capacity of the government to conduct sound economic policies that foster economic growth and prosperity.
The third factor, Fiscal Strength, captures the overall health of government finances. The starting point being an assessment of relative debt burdens (debt/GDP, debt/revenues) and debt affordability (interest payments relative to revenue and GDP). The structure of government debt is also taken into consideration at this stage.The last factor considered was Namibia’s Susceptibility to Event Risk. While the first three rating factors (Economic Strength, Institutional Strength and Fiscal Strength) are aimed at assessing the government’s ability to withstand shocks from a medium-term perspective, the fourth factor gauges the severity of the strain that extreme events may have on public finances, and the probability of default.
Based on the Exhibit 1 above we formulated a regression model, to determine the weight of the factors considered. Our computation suggested the weights indicated below:
The model indicates that factor 4 (Susceptibility to Event risk) and factor 3 (Fiscal Strength) are the factors with the highest weighting on the final Sovereign Bond Rating. Therefore, in order to decode Moody’s rating, we have to pay more attention to our Fiscal Strength and Vulnerability to event risk.
GOVERNMENT FISCAL STRENGTH
Factor 3, Government Fiscal Strength is assessed equally on Debt burden and Debt affordability. The level of government debt relative to GDP (42.1%) and revenues (about 130%) was on a rapid upward trend from a low base. The public debt to GDP ratio exceeds the self-imposed prudential limit of 35%. Moreover, contingent liabilities to state-owned enterprises, are projected to rise over the next several years. Despite rapid debt accumulation in recent years, Moody’s believe that Namibia’s other fiscal indicators (interest costs relative to revenue) remain solid relative to those of peers and projects them to remain so in the coming years provided that the government succeeds in its fiscal consolidation plans. The stock of total (public and private) external debt has also increased rapidly, from 42% of GDP in 2014 to about 60% in 2016, while foreign currency denominated share of public debt accounted for almost half of the public debt in the 2016/17 fiscal year.
Although in the past, this was primarily comprised of bilateral and multilateral borrowings, the share of this type of loans has fallen since the government began issuances on the Eurobond market in 2011 and 2015. The stock of Eurobond debt accounted for 68.6% of total external government debt in 2015, in contrast to 100% of combined bilateral and multilateral foreign currency debt in 2010. The key components under factor 3 are government revenue, government debt and GDP. Therefore, to improve our score on factor 3: we need to either sustainably increase government revenue, reduce government debt or accelerate GDP growth. It stands to reason that, in the near to medium term, of these three variable the one we could easily control is government debt, by either bulleting debt or establishing enforceable mechanisms to prevent further unauthorized expenditure.
SUSCEPTIBILITY TO EVENT RISK
Breakdown of Factor 4: The analysis comprises four areas of event risk: Political Risk, Government Liquidity Risk, Banking Sector Risk and External Vulnerability Risk. Generally speaking, the Susceptibility to Event Risk gauges the probability of the event by its severity in terms of its impact on Namibia’s creditworthiness. The aggregation of the four rating sub-factors of event risk uses a maximum function as the materialization of even one of these risks can lead to a severe deterioration of Namibia’s credit profile. Therefore, for factor 4 the emphasis is on things we should not do in order to avoid further downgrade. In the near to medium term we should avoid deterioration in government’s liquidity position and our external vulnerability.
CROSS CUTTING MEASURES
In order to ensure sustainability, over the medium to long term we must resolve the structural economic issues plaguing our economy, by putting emphasis on policies such as Growth-At-Home, monetizing non-core government assets and introducing select SOEs to private funding mechanisms. The imperative of monetizing or introducing market funding mechanisms to state assets is in that it will enable government to bullet some of the public debt and inject efficiencies given the return driven nature of private capital. We need to classify the SOEs into the following three categories; Core, Strategic and Non-Core. The strategic SOEs must be run efficiently and in a sustainable manner. On the other hand, the none core assets render themselves the most appropriate for PPP via partial commercialization.
By their very nature, solutions to economic structural issues are medium to long term exercises but we should however not delay commencing to execute them, a journey of a thousand miles starts with one step. In keeping with that, at NEB, we have started an exercise which is intended to decode the thinking of rating agencies so as to enable us to correctly keep track of our economy’s health indicators. Through this exercise we determined the weights of the four factors used by Moody’s to rate Sovereign Bonds and arrived at a rating of Ba1.
*This article was compiled by the Namibia Equity Brokers Research team comprised of Alfred Kamupingene, Ngoni Bopoto and Elvis Katuuo.