Nicaragua: Slight Improvement in Risk Outlook

Fitch Ratings decided to keep the country's risk rating at B, but changed the outlook from negative to stable, arguing that there are some signs of stabilization of Central Bank reserves and commercial bank deposits.

Monday, November 25, 2019

The revision of the outlook reflects the stabilization of central bank reserves and commercial bank deposits, a significant fiscal adjustment and social security reform that have reduced domestic financing needs and a pronounced external rebalancing that has facilitated the external financing requirement, the rating agency reported.

From the Fitch Ratings statement:

Fitch Ratings - New York - 22 November 2019: Fitch Ratings has affirmed Nicaragua's Long-Term Foreign Currency Issuer Default Rating (IDR) at 'B-' and revised the Outlook to Stable from Negative.

KEY RATING DRIVERS


The revision of the Outlook reflects the stabilization of central bank reserves and commercial bank deposits, a significant fiscal adjustment and social security reform that have reduced domestic financing needs, and a pronounced external rebalancing that has eased the external financing requirement. Nicaragua's ratings reflect its low economic growth prospects and income per capita, political stability risks, government debt metrics in line with the 'B' median, larger net external debt and external financing constraints relative to the median.

The political environment has stabilized after serious political violence in 2018, although significant downside risks remain. During 2019, the government released some participants apprehended during the April 2018 demonstrations, and some of the opposition leaders who fled the country, have returned. The political crisis, violence, and further centralization of political powers during 2018 are reflected in a 10pp fall in Nicaragua's composite World Bank governance indicator ranking to 18.2, comparing unfavorably to the 'B' median of 38.2.

International reserves have stabilized after significant deposit flight in 2018 and a large current account adjustment. Reserves were USD2.2 billion in September 2019 (USD190 million of which was borrowed from Central American Bank for Economic Integration) equivalent to 3.9 months of current external payments (on par with the current 'B' median). A sharp contraction of investment and consumption compressed imports during 2018-2019, while exports held up and remittances rose, moving the current account into surplus compared to deficits averaging 6.9% of GDP during 2014-2017. Fitch expects the current account to remain in surplus over the forecast period, although it will decline from a projected 2.6% of GDP in 2019 to 2.1% by 2021 as imports increase gradually.

The government has maintained access to external financing, but at higher interest rates and shorter maturities. The Central American Bank for Economic Integration (CABEI) has filled part of the external financing gap caused by the U.S. NICA Act's impact on disbursements from the Inter-American Development Bank (IADB). In October, the government signed a new multi-year USD585 million facility with CABEI. The U.S. government continues to sanction senior Nicaraguan officials, and an escalation of sanctions remains a risk.

Nicaragua's external debt service metrics are at or below the current 'B' median. Net external debt/GDP (2019: 48.3%) is more than double the current 'B' median, mainly reflecting concessional Petrocaribe debt owed to Venezuela.

The stabilization of deposits at commercial banks and the current account surplus have reduced pressure on the crawling peg. The central bank reduced to 3% from 5% the annual depreciation of the Cordoba-US dollar exchange rate effective November 1. Fitch expects that lower Cordoba depreciation will reduce the government's debt servicing costs, including on domestic debt as this is mostly indexed or in USD. Exporters and recipients of remittances will see less gain from FX receipts and the banks from USD/indexed loans. The crawling peg remains the key macro policy anchor for the highly dollarized economy and financial system (74% of deposits, 89% of credit).

Nicaragua's largely foreign-owned commercial banks appear to have weathered the political crisis. Deposits rose by 4.2% between July and October 2019 after a sharp fall that began in 2018; similarly, credit had the first month-on-month growth in October after 17 months of contraction. Nonetheless, the stock of credit/GDP had declined to 29.1% in October 2019 from a peak of 40.6% in April 2018 after banks cut credit lines and increased liquidity (49.7% in September). Nicaragua's banks entered the crisis with stronger capital positions than Central American averages, and the authorities have allowed emergency credit restructuring measures which avoided sharp increases in write-offs. The weak economy has caused asset quality to deteriorate.

There has been a significant fiscal adjustment in 2019. Social security (INSS) and tax reform are projected to narrow the consolidated general government deficit to 0.5% of GDP from 3.1% in 2018. Fitch forecasts that new tax measures will lift central government revenues by 13.8% in 2019, while expenditures will be contained close to their 2018 level. Public workers did not get the usual 5% salary increase in 2019 and will not get the adjustment in 2020. Transfers to municipalities were reduced to 4% of tax revenue from 10%. An increase in contributions from workers and employers and a 25% average fall in new pensions will narrow the INSS deficit to 0.6% of GDP from 1.1% in 2018. Fitch expects a modest widening of the deficit in 2020 and 2021 driven by the INSS' weak actuarial position.

Government domestic financing costs have risen and maturities have shortened. As of November 2019, the government has issued local bonds raising USD162 million, more than it did in 2017 (USD125m). However, this issuance has been at a higher cost (in 2019 the weighted average interest rate rose to 10.7% from 8.9% in 2017), shorter maturity (1 and 2 years versus 3-7 years), and involved instruments denominated and payable in US dollars (versus indexation previously).

Nicaragua's GG debt/GDP (2019: 46.4%) is close to the 'B' median (2019: 49.7%), although we expect it to gradually rise driven by the INSS deficit. The concessionality of debt means that interest payments (4.2% of revenues for 2019) are half the 'B' median and external amortizations are relatively low with a smooth profile.

Fitch expects that the economy will contract for the second consecutive year, with real GDP falling by 4.3% in 2019 after a 3.8% contraction in 2018. Consumption indicators and formal employment are weak, with firm export performance and remittances providing support. The availability of economic activity data has diminished during 2019, with no quarterly GDP data published. The economic outlook for 2020-2021 is uncertain given the fall in capital investment and timid pickup in credit; Fitch expects growth to be flat.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Nicaragua a score equivalent to a rating of 'CCC+' on the Long-Term Foreign-Currency (LT FC) IDR scale.

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:

--Macroeconomic policy and performance: +1 notch, to reflect Nicaragua's consistent external and fiscal policy response that supports credibility of the crawling peg.
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.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to a positive rating action are:
--A recovery of financial, investment, and economic conditions;
--A sustained reduction in political risk.
The main factors that could, individually or collectively, lead to a negative rating action are:
-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.

KEY ASSUMPTIONS

--Fitch assumes the global economy and international oil prices perform in line with our Global Economic Outlook.

ESG CONSIDERATIONS

Nicaragua 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. Since 2018, when demonstrations against the government led to a significant death toll, there has been a deterioration in political stability.

Nicaragua has an ESG Relevance Score of 5 for Rule of Law, Institutional and Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in the SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.

Nicaragua has an ESG Relevance Score of 4 for Human Rights and Political Freedom as World Bank Indicators have the highest weight in Fitch's SRM and are therefore relevant to the rating and are a rating driver.

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



More on this topic

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Fitch Ratings kept in B+ with a negative outlook, the sovereign debt rating, arguing that "the weaknesses in public finances are reflected and the political stagnation has prevented the timely approval of reforms that address these problems."

The new fiscal rule has not been approved, and the Congressional authorization requirement for foreign loans periodically restricts Costa Rica's financial flexibility, is another of the risk qualifier's arguments.

Fitch Downgrades Nicaragua's Debt Again

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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.

El Salvador: Debt Rating Confirmed

June 2018

Fitch Ratings has kept the debt rating in foreign currency at "B-", arguing that political tension has been reduced following the pension reform approved in October last year and the budget passed in January of this year.

Fitch Ratings-New York-13 June 2018: Fitch Ratings has affirmed El Salvador's long-term, foreign-currency Issuer Default Rating (IDR) at 'B-' with a Stable 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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