Fitch Ratings has affirmed Benin’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘B’ with a Positive Outlook.
Key Rating Drivers
Benin’s ‘B’ rating balances its moderate government debt/GDP, track record of low inflation and strong GDP growth performance against its low GDP per capita, limited economic diversification, sizeable current account deficit, vulnerability to external shocks and weak banking sector.
The affirmation and Positive Outlook balances the improvement in several of Benin’s public finance, external finance and other ratios related to the methodological changes and rebasing of GDP statistics published this year, as well as a track record of fiscal consolidation since 2016, against the heightened macroeconomic and fiscal risks resulting from the recent border closure with Nigeria.
Nigeria’s closure of its border with Benin since August represents a potentially sizeable external shock, with adverse implications for Benin’s economy and public finances. Benin’s informal re-exports to Nigeria account for 70% of Benin’s total exports and are equivalent to about 20% of GDP (but much lower on a value added basis given the high import content), while trade taxes account for around 35% of government revenues. The impact on the economy is uncertain and will depend on how effective it is on a 800km and still partially porous border, spill-over effects and how long the closure remains in place.
Available data up to October suggest that monthly imports have remained stable, but this likely also reflects shipment time lapses and a wait-and-see attitude from exporters to Benin given uncertainty over a potential resolution. Fitch does not expect the situation to have a significant impact on fiscal revenues and on economic activity in 2019 with GDP growth forecast to decline to 6.5% in 2019 from 6.7% in 2018 as buoyant performances in the agricultural, construction and transports sectors partially offset dampened informal re-exports to Nigeria.
Our baseline scenario is that the border is reopened in 1H20, but this remains uncertain and there is a downside risk of a more lengthy closure. Nigeria shut the border in a bid to curb informal imports and recently extended the closure of its border until end-January 2020 and discussions between both governments are on-going.
A prolonged border closure could have broader reverberations on the economy and government revenues, employment and the banking sector, beyond the hit on informal trade. In particular, it could lead to fiscal slippages, as a result of a reduction in government receipts from duties on imports informally re-exported to Nigeria, which were equivalent to around 3.5% of GDP in 2019, as well as potential additional spending to address social concerns and stimulate growth.
Methodological changes and the rebasing of GDP to 2015 from 2007, in line with international standards, have generated a 36% upward revision of 2015 nominal GDP. This has led to an improvement in several indicators and credit ratios including GDP per capita, government debt/GDP, government balance (% of GDP) and the current account balance plus FDI (% of GDP), which feed into Fitch’s Sovereign Rating Model (SRM), leading to a revision in the model output to ‘B+’ from ‘B’. Although the data revisions have been trailed for some time, Fitch could not incorporate them into its data and forecasts until a full official series was published.
Benin’s underlying public finances are also improving. Fitch projects the fiscal deficit to narrow to 2.3% of GDP in 2019 from 2.9% in 2018, and then to further decline to 2.2% in 2020 and 2.0% in 2021 if the border reopens in 1H20. We expect Benin to remain committed to moderate fiscal deficits and to renew the IMF programme that is scheduled to expire in 2020. Contained fiscal deficits mean general government (GG) debt is set to decline to 39% of GDP in 2021 from 41% at end-2019, well below the ‘B’ median of 57% of GDP on average over 2019-2021. Contingent liability risks are small as state-owned enterprises debt represents 1% of GDP and the government has not yet signed public-private partnerships under the 2016-2021 Government Action Programme (PAG).
Under a border issue stabilisation scenario, medium-term prospects for economic activity would remain solid, with GDP growth forecast to average 6.8% over 2020-2021, well above the ‘B’ 3.4% median. Our forecast assume the impact of the border closure over part of 2020 would be offset by a continued increase in agricultural production and construction activity supported by large ongoing infrastructure projects under the PAG. In addition, improved access to electricity and reforms to improve the business environment has laid the ground for a more favourable growth environment.
Financing options have improved but remain narrow. Benin’s first Eurobond (EUR500 million; 5.75% coupon; maturing in 2026) issuance in March 2019 has allowed the country to diversify sources of financing, but exposes Benin to new refinancing risks, given fluctuant international capital market conditions. In addition, Benin remains somewhat dependent on official creditor financing and the regional West African Economic and Monetary Union market is shallow.
We forecast interest expenditure to average 11.7% of government revenues over 2019-2021, in line with the ‘B’ median. The buyback of costly domestic debt in October 2018, financed by a EUR260 million commercial loan with a partial World Bank guarantee contributed to containing interest expenditure. We expect the government to pursue a proactive debt management strategy and to give priority to concessional financing over commercial funding.
External finances remain weaker than peers. There is a sizeable current account deficit, which the agency forecasts at 5.5%-6.0% of GDP between 2019 and 2021, including estimates of informal trade flows. Increased agricultural exports and lower food imports, and scaling down of public investments will help to contain the position.
Banking sector health metrics are weaker than for peers. Bank capitalisation has decreased, with the capital adequacy ratio dropping to 8.2% end-2018 from 11.9% end-2017. Gross non-performing-loans levels are high, representing 20.4% of total loans at end-2018 from 19.4% in 2017, owing to poor oversight in the banking sector, which risks undermining credit growth. Risks for the sovereign from the banking sector are mitigated by its relatively small size and the high share of foreign-owned banks.
Governance indicators are comparable with the ‘B’ median. Benin witnessed episodes of social unrest following the April 2019 parliamentary elections, but public demonstrations have since subsided. The national dialogue with the opposition launched by the President Patrice Talon has led to political and institutional changes that were reflected in a constitutional reform. However, in Fitch’s view, it is unlikely it will durably address political tensions prior to the February 2020 municipal elections, but we expect the authorities to contain disruptions. The constitutional reform has also introduced key changes to the political life, including the limitation to two mandates for a president and the creation of a presidential ticket with a vice-president.
Sovereign Rating Model (SRM) And Qualitative Overlay (QO)
Fitch’s proprietary SRM assigns a score equivalent to a rating of ‘B+’ 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:
– External Finances: -1 notch to reflect the vulnerability to external shocks including significant exposure to the Nigerian economy. The closure of the Nigerian border represents a potentially sizeable external shock, with adverse implications for Benin’s economy and public finances, depending on the effectiveness of the closure, how long it remains in place and Benin’s resilience to the developments.
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 main factors that could, individually or collectively trigger positive rating action are:
The reopening of the border with Nigeria or evidence of the resilience of Benin’s economy and public finances to its closure
A reduction in government debt to GDP, for example as a result of maintenance of moderate fiscal deficits
A significant decline in current account deficits and net external indebtedness, for example through higher export receipts
The main factors that could, individually or collectively trigger negative rating action are:
Material adverse effects on Benin’s economy, public finances or external position from the border closure with Nigeria
Weaker medium-term growth prospects, for example resulting from delays to structural reforms or the emergence of macroeconomic imbalances
An increase in government debt/GDP, for example as a result of a looser fiscal stance
We assume that key features of the West African Economic and Monetary Union and the monetary arrangement with France, including the peg to the euro, the pooled regional reserves and the convertibility guarantee from CFA franc to euro, will remain unchanged in the medium term and continue to support macroeconomic stability. We also assume the fixed parity of the CFA franc with the euro will remain unchanged.
We expect commodity prices and global economic trends to develop as outlined in Fitch’s most recent Global Economic Outlook.
Benin 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 therefore highly relevant to the rating and are a key rating driver with a high weight.
Benin 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 weigh.
Benin has an ESG Relevance Score of ‘4’ for Human Rights and Political Freedoms, as the Voice and Accountability pillar of the World Bank Governance Indicators are relevant to the rating and a rating driver.
Benin 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, as for all sovereigns.
Benin has an ESG Relevance Score of 4 for International Relations and Trade as dependence on trade to Nigeria is relevant to the rating and is a rating driver.