Cape Verde Ratings


OVERVIEW
  • In our view, Cape Verde's economic growth prospects are favorable and it benefits from relatively strong institutions. However, net general government debt and current account deficit levels remain high.
  • We are therefore affirming our 'B/B' ratings on Cape Verde.
  • The stable outlook reflects our view that the risks of a weaker-than-anticipated fiscal and balance of payments performance are offset by the potential for stronger growth dynamics over the next year.
OUTLOOK

The stable outlook reflects our view that the risks of a 
weaker-than-anticipated fiscal and balance of payments performance are offset 
by the potential for stronger growth dynamics over the next year.

We could lower the ratings if Cape Verde's balance of payments performance 
weakened compared to our current projections, for example, as a result of a 
tourism sector deterioration. We could also lower the ratings if government 
debt increases faster than our forecasts.

We could raise the ratings if fiscal pressures were to reduce materially, as 
evidenced by a credible fiscal adjustment effort that puts the country's 
public debt on a firm downward path and addresses the persistent financial 
problems faced by several state-owned enterprises. We could also consider a 
positive rating action if the external pressures were to dissipate, for 
example, due to a higher-than-anticipated positive impact from tourism and 
foreign investment, supporting higher growth prospects and a reduction in 
public debt ratios.

RATIONALE

The ratings on Cape Verde are constrained by our view of its weak public 
finances, which are somewhat mitigated by the high share of concessional 
funding and long repayment maturities, its low level of economic wealth, and 
its vulnerable external position.

The country's economic growth prospects remain favorable, benefitting from 
significant tourism-related net foreign direct investment (FDI) inflows as 
well as a stable institutional framework.

Institutional and Economic Profile: Tourism sector is driving economic growth
  • We expect Cape Verde to grow by an average of 3.6% over 2017-2020, supported by foreign investment and tourism sector activity.
  • The main risks to growth are external factors that could result in a slowdown in British and European tourist arrivals.
  • Policy choices have dented public finances, as evidenced by the large and growing government debt burden driven by support to state-owned enterprises.

Cape Verde's real GDP growth rebounded to 3.8% in 2016, up from 1.0% in 2015. 
The improved performance reflects strong inflows of FDI, higher consumption 
following a hike in some public sector salaries, and a rapidly growing tourism
sector. We expect growth to average 3.5% over the next two years and trend 
toward 3.8% by 2020, higher than the average growth of 1.5% per year over 
2010-2015. We project that FDI--mainly in tourism-related projects--will 
continue to rise and construction and trade will pick up as a result. A number
of upcoming hotel and casino projects will significantly expand the capacity 
of the tourism sector.

However, most of the goods consumed by tourists are imported rather than 
locally produced, limiting positive spillover effects to the domestic economy.
Higher FDI inflows over the next two years will keep imports of goods and 
services high and, as a result, current account deficits will remain wide. 
Over the longer term, we expect that tourism will start contributing more 
positively to GDP, especially as higher-end tourism projects are finalized and
there are improvements in the quality and reliability of agriculture 
production and transportation links between the islands.

As the government scales back its public investment program, growth will be 
contingent on rising private sector activity. Although we have seen stronger 
credit growth recently, the private sector remains moderately leveraged at 
around 60% of GDP and nonperforming loans are high at 15.5% of total loans, 
which could constrain lending to the private sector going forward. We also 
expect the growth in remittance flows to slow as increased diaspora support, 
provided after the volcanic eruption on the Fogo island, moderates, which 
could reduce consumption growth.

The economy remains concentrated in the tourism sector, leaving Cape Verde 
susceptible to external factors such as an outbreak of Zika virus, Brexit, or 
weaker economic recovery in Europe resulting in a slowdown in tourist 
arrivals, although this is not our baseline scenario.

In our view, Cape Verde's past policy choices have not been conducive to 
delivering strong public finances. The country's public debt level has risen 
steeply over the last few years and last year's increase exceeded our 
expectations, owing primarily to government support provided to several 
state-owned enterprises facing financial stress.

However, we note that Cape Verde remains one of the most stable democracies in
Africa, with a functioning system of checks and balances between government 
institutions and free flow of information, which facilitates predictability of
policymaking.

Following parliamentary elections in March 2016 and presidential elections in 
October 2016, the former opposition party, Movement for Democracy (MpD) now 
controls both the presidency (which it regained earlier in 2011) and the 
parliament. The new government is prioritizing fiscal consolidation to reduce 
public debt and accelerating the privatization of loss-making state-owned 
enterprises (SOEs). We have seen some recent positive developments in the 
management of some SOEs, particularly the national airline TACV. Since 2017, a
Canary Island-based airline, Binter, has taken over the operations for 
domestic flights within Cape Verde and an operations management contract has 
recently been signed with Loftleidir Icelandic to run national airline TACV's 
international routes. We expect government support to SOEs to slow toward 
2020, as there is further progress on restructuring or privatization, which 
would support a gradual decline in government debt levels.

Cape Verde maintains strong political and economic ties with Portugal. The two
countries signed a €120 million (8.2% of GDP) credit line in 2017, which will 
be disbursed to Cape Verde during the 2017-2021 financing round. Under a 
Foreign Exchange Cooperation Agreement, Portugal also provides Cape Verde with
an €45 million (4.7% of current account payments) line of credit for balance 
of payment support in case of need, subject to compliance with a mutually 
agreed macroeconomic program.

Flexibility and Performance Profile: Government debt and external liabilities 
to remain high, while debt-servicing risk will rise
  • Cape Verde's public debt burden remains very high at an estimated 124% of GDP as of end-2016.
  • We project that debt levels will reduce gradually through to 2020 on the back of lower public spending and lower financial support to SOEs.
  • While Cape Verde's monetary flexibility is constrained by the escudo-euro peg, low and stable inflation trends follow those of the eurozone.

Cape Verde's gross general government debt increased to 124% of GDP at 
end-2016, which is high on a global comparison and among the highest of the 
African sovereigns that we rate. The large increase in leverage over the last 
few years primarily reflects the government's extensive investment program, 
which has been mostly funded by concessional external debt with an average 
interest rate of around 1.5%. Nevertheless, because of the low level of 
revenues and the large stock of debt, debt service costs are relatively high 
at a projected 11% of government revenues on average in 2017-2020. We also 
expect eligibility for these concessional loans to reduce owing to the 
sovereign's graduation from lower- to middle-income country status. We believe
pressures on public finances will rise as grace periods expire and the 
government amortization requirements gradually increase over the next decade. 
In addition, about three-quarters of general government debt is denominated in
foreign currency, resulting in vulnerability to foreign currency risk.

Cape Verde's net general government debt is somewhat lower than its gross 
debt, reflecting fiscal assets equal to about 15% of GDP. These comprise 
deposits at the central bank and commercial banks, as well as foreign-invested
funds earmarked for domestic debt service. We forecast net general government 
debt will peak at 118% of GDP in 2018 before gradually declining thereafter, 
owing to stronger growth and the authorities' fiscal adjustment efforts.

The general government deficit reduced to 2.4% of GDP in 2016, from 4.0% in 
2015 and 7.8% in 2014, according to the Banco de Cabo Verde (BCV). 
Nevertheless, as in the past, the stock of government debt increased at a 
faster pace than that implied by the headline deficit in 2016, totaling about 
5.4% of GDP last year. This is primarily explained by onlending and capital 
contributions that the government undertook in relation to financially weak 
state-owned enterprises, including the housing company IFH and TACV. We 
anticipate that more contributions could be necessary over the next few years 
and consequently government debt will keep increasing at a faster pace than 
the headline deficit. The IMF estimates that contingent liabilities stemming 
from the country's SOEs amounted to about 25% of GDP at end-2015. In addition,
we believe vulnerabilities remain in Cape Verde's banking system, which pose a
moderate contingent liabilities risk to public finances.

The "Casa Para Todos" program run by IFH was signed in January 2010 to build 
and sell affordable housing in Cape Verde. The program is funded by a credit 
line of up to €200 million from Caixa Geral de Depósitos (CGD), a wholly 
state-owned Portuguese bank, to the government of Cape Verde. The government 
has recently amended the program arrangements whereby some of the social 
housing are now being sold at market prices and the government envisions other
changes to the program, subject to reaching an agreement with the Portuguese 
government. However, as we understand, restructuring of the related credit 
line may not form part of the broader review of the program.

To date, the government has withdrawn €160 million (11% of GDP) from the CGD 
credit line. We understand from the authorities that the loan is on favorable 
terms and benefits from a guarantee provided by Portugal. We note that 
principal repayments on the outstanding loan do not start until 2022 and, 
therefore, immediate repayment pressures are unlikely.

We also note that state-guaranteed debt of TACV of around €20 million from a 
commercial creditor was restructured. This measure is in line with the 
government's strategy to improve the debt profile of SOEs and should support 
privatization efforts. We understand from the authorities that the government 
guarantee did not constitute a timely guarantee but is more akin to a 
guarantee of ultimate payment in the event of insolvency of the debtor.

Deflationary pressures over the last two years have also had a dampening 
effect on nominal GDP growth and government revenues, precluding a reduction 
in public debt-to-GDP ratios. We expect inflation to rebound only gradually 
over the forecast period.

Although we now estimate Cape Verde's external imbalances to be somewhat 
smaller than before, we still view the sovereign's external position as a 
ratings weakness. We estimate that external debt net of liquid public and 
financial sector external assets will average roughly 87% of current account 
receipts over 2017-2020. The net external liability position is even weaker, 
reflecting sizable inbound tourism-related FDI. We believe Cape Verde could be
vulnerable if investor sentiment were to turn and FDI inflows were to stop 
suddenly.

The ratings on Cape Verde remain constrained by the limited flexibility of the
monetary policy. However, while the escudo's peg to the euro has contributed 
to low and stable inflation, it has tied the BCV's monetary policy to that of 
the European Central Bank. We expect the escudo-euro peg will remain in place 
over the medium term.


KEY STATISTICS

Table 1

Republic of Cape Verde Selected Indicators
2011201220132014201520162017201820192020
ECONOMIC INDICATORS (%)
Nominal GDP (bil. LC)148150154154159162168175185197
Nominal GDP (bil. $)2222222222
GDP per capita (000s $)3.73.43.63.53.03.03.13.33.43.6
Real GDP growth4.01.10.80.61.03.83.53.53.73.8
Real GDP per capita growth2.8(0.1)(0.4)(0.6)(0.2)2.52.32.32.52.6
Real investment growth5.6(23.5)(12.0)14.9(15.8)6.06.55.03.02.0
Investment/GDP47.537.231.637.030.231.232.232.531.830.8
Savings/GDP31.223.125.827.925.327.224.624.825.425.6
Exports/GDP35.540.440.540.444.945.346.347.548.549.3
Real exports growth10.913.50.6(1.2)14.83.04.54.75.05.0
Unemployment rate12.216.816.415.812.415.013.012.011.011.0
EXTERNAL INDICATORS (%)
Current account balance/GDP(16.3)(14.1)(5.8)(9.1)(4.9)(3.9)(7.6)(7.6)(6.4)(5.2)
Current account balance/CARs(24.4)(22.4)(9.1)(14.0)(8.2)(5.9)(11.7)(11.7)(9.6)(7.8)
CARs/GDP66.862.863.864.860.267.464.865.366.667.1
Trade balance/GDP(45.2)(37.7)(33.6)(32.5)(30.1)(33.3)(34.2)(34.5)(33.8)(32.9)
Net FDI/GDP5.46.83.19.07.06.77.06.54.54.0
Net portfolio equity inflow/GDP0.00.00.00.00.00.00.00.00.00.0
Gross external financing needs/CARs plus usable reserves136.2150.1148.8162.2149.4136.5141.1146.7132.7128.5
Narrow net external debt/CARs81.5103.6108.096.5113.990.5100.188.584.778.1
Net external liabilities/CARs164.6226.8228.1206.4242.8215.2231.1221.8215.1205.9
Short-term external debt by remaining maturity/CARs19.435.040.049.342.234.733.335.231.929.5
Usable reserves/CAPs (months)0.50.50.00.10.10.30.30.00.70.8
Usable reserves (mil. $)5328733311849495
FISCAL INDICATORS (%, General government)
Balance/GDP(7.7)(12.4)(9.3)(7.8)(4.0)(2.4)(3.5)(3.2)(3.0)(2.0)
Change in debt/GDP12.910.113.714.311.15.47.50.25.03.0
Primary balance/GDP(6.2)(10.5)(7.1)(5.6)(1.4)0.2(0.7)(0.3)(0.1)0.8
Revenue/GDP25.624.424.522.926.426.626.526.025.525.5
Expenditures/GDP33.336.833.930.730.429.030.029.228.527.5
Interest /revenues6.07.89.09.79.99.810.411.211.311.1
Debt/GDP78.587.399.1113.0121.1123.7127.4122.1120.4116.5
Debt/Revenue306.1357.8404.0493.9459.3465.0480.7469.5472.2456.8
Net debt/GDP63.674.986.298.7106.0107.3111.5113.3112.1108.7
Liquid assets/GDP14.912.412.914.315.016.415.98.78.37.8
MONETARY INDICATORS (%)
CPI growth4.52.51.5(0.2)0.1(1.4)(0.3)1.02.02.2
GDP deflator growth2.70.61.4(0.1)1.7(1.4)(0.3)1.02.02.2
Exchange rate, year-end (LC/$)85.5583.1080.0090.68100.92105.4993.6397.7796.9196.07
Banks' claims on resident non-gov't sector growth14.9(0.1)1.8(1.0)2.83.53.53.53.53.5
Banks' claims on resident non-gov't sector/GDP66.064.964.663.663.664.464.663.962.661.0
Foreign currency share of claims by banks on residentsN/AN/AN/AN/AN/AN/AN/AN/AN/AN/A
Foreign currency share of residents' bank deposits3.13.32.82.02.22.3N/AN/AN/AN/A
Real effective exchange rate growth2.1(1.0)(1.5)(1.0)(1.8)(1.5)N/AN/AN/AN/A
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