Fitch Downgrades Nicaragua to 'B'

The downgrade and Outlook change reflect increasing political instability and the corresponding deterioration of Nicaragua's investment, economic growth, and public finance outlook

Monday, June 25, 2018

From a statement issued by Fitch Ratings:

Fitch Ratings-New York-22 June 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 follows at the end of this rating action commentary.

KEY RATING DRIVERS 

The downgrade and Outlook change reflect increasing political instability and the corresponding deterioration of Nicaragua's investment, economic growth, and public finance outlook. Declining deposits and incipient related pressure on international reserves have increased financial and macro stability risks in the context of Nicaragua's crawling peg exchange rate regime and highly dollarized financial system. Uncertainty over the course of domestic political events presents downside risks to Fitch's forecasts.

Domestic political unrest has claimed at least 215 lives since April 18. Protests sparked by a social security reform reflect political polarization surrounding President Daniel Ortega's consolidation of influence over public institutions since his return to power in 2007. Violence has escalated and risks of a protracted civil conflict are increasing. The military has not intervened to date. A national dialogue mediated by religious officials between President Ortega and his wife and Vice President Rosario Murillo, and a broad group of business, student, rural activist, and civic groups has been unable to negotiate a solution.

There has been pressure on the financial system's highly dollarized and short-term deposit base and the central bank's international reserves. Bank deposits have fallen by USD665 million (12%) from April 17 to June 19, of which USD285 million net outflows occurred since May 30. In response, the central bank has increased daily liquidity management operations and has introduced new instruments. However, the Cordoba's crawling peg exchange rate to the U.S. dollar, the macro policy anchor, limits the central bank's scope to increase the money supply. The banks had adequate capital (14.3% as of April) and liquidity (34.1% as of June 20) ratios. Fitch placed the national scale ratings of the rated financial institutions in Nicaragua on Rating Watch Negative on June 15, reflecting the deterioration in their operating environment and the potential negative impact on their financial performance and funding.

External liquidity metrics are in line with peers. Central bank net foreign exchange sales to commercial banks and a drawdown of central government deposits have reduced net international reserves by USD293 million (10%) from April 17 to June 20. Net international reserves of USD2,623 million at June 20 cover 3.7 months of current external payments, on par with the 'B' median of 3.9 months. The central bank also has a USD200 million external liquidity line available from the Central American Bank for Economic Integration. Nicaragua's smooth external amortization profile supports its international liquidity ratio at close to 200%. Its external debt service ratio, close to 11% of current external receipts, is in line with the 'B' median of 12%. 

Fitch expects the current account deficit (CAD) to widen to 8% of GDP in 2018 due to higher fuel import payments and a likely fall in revenues from tourism and some agricultural exports. The strong recovery of agricultural exports and moderate oil prices during 1H17 resulted in the historically low current account deficit of 5% of GDP in 2017. Exports of Nicaragua's main agricultural and manufactured goods plus remittance receipts continue to sustain the inflow of foreign exchange to the trade-dependent economy.

FDI, which financed most of the CAD the past five years, is expected to decrease by USD200 million under the baseline scenario. Foreign investment is sensitive to further negative shocks (property rights, security, or infrastructure quality), and a shortfall would undermine Nicaragua's ability to finance the CAD, which exceeds the 'B' median in most years, and potentially put pressure on international reserves. Nicaragua's current account deficit, net external debt (48% of GDP), and commodity export dependence (38% of current external receipts) exceed the 'B' median.

Fitch expects under its base case scenario that the political crisis will lower Nicaragua's economic growth to 1.7% in 2018, from its 4.8% five-year average during 2013-2017. The road blocks and threat of violence against civilians have suppressed retail commerce, restaurant and tourism services, construction, and delayed goods deliveries. The breakdown of the government's consensus model of business-sector consultation reduces the predictability of macroeconomic policymaking and weakens the investment climate. Inflation is forecast to rise to 7.5% yoy in 2018, up from 3.9% in 2017. Higher fuel import prices since 4Q17 have passed through to the economy, and shortages increased food prices in May, when inflation reached 5.2% yoy.

The general government deficit is forecast to widen to 1.9% of GDP in 2018 from 1.3% in 2017. This assumes that tax receipts will fall in line with lower commerce and employment and that the government will attempt to maintain budgeted expenditure to support economic stability. The social security institute (INSS) deficit is expected to deteriorate during 2018-2020 from 0.6% of GDP in 2017, and it will increase the government's financing needs as the INSS's liquidity reserves are expected to be depleted in 2018.

The public financing strategy faces potential risks, in our view. Domestic treasury auctions have slowed during April-June as banks preserve liquidity, which could affect the USD100 million the government plans to place in the local market in 2018. Externally, human rights concerns could encumber Nicaragua's access to concessional financing from multilateral lenders. 

General government debt/GDP, at 41.8%, is in line with the 'B' median of 44.2%, supported by Nicaragua's track record of public financial management, domestic debt repayments, and external debt reduction under the Heavily Indebted Poor Country Initiative. However, the debt burden is expected to rise over 2018-2020 driven by higher financing needs and interest expense. Nicaragua's sovereign external debt consists largely of highly concessional multilateral loans. Public institutions and the central bank hold more than half of its internal debt. These factors partially mitigate refinancing and rollover risks. 

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 centered 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.



More on this topic

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Fitch Downgrades Nicaragua's Debt Again

November 2018

Justifying a larger-than-expected economic contraction, a growing fiscal deficit and a greater risk of internal and external financial constraints, the rating agency lowered the rating from B to B-.

This is Fitch Ratings' second downgrade so far this year. In the first quarter, the rating was B+ with a solid outlook, in the second quarter the rating agency downgraded it to B with a negative outlook, and now it downgraded it to B-, and kept the negative outlook.

Nicaragua as seen by Fitch Ratings

August 2017

The rating agency highlights growth at rates of 5% achieved in the last five years, but estimates that in 2017-18 this will fall to 4.5%, partly due to the effect of a reduction in financial flows from the program with Petrocaribe.

From a statement issued by Fitch Ratings:

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