Mozambique Foreign Currency Ratings Affirmed At 'SD/SD'; Local Currency Ratings Affirmed At 'B-/B' With Stable Outlook

  • Negotiations on the restructuring of Mozambique's US$727 million Eurobond maturing in 2023 are ongoing, after the government of Mozambique announced in November 2018 that it had reached an agreement in principle with 60% of creditors. For restructuring to take place, 75% of creditors are required to agree.
  • We will reassess the foreign currency rating on Mozambique when the restructuring takes place, although the timeline remains unclear. We expect Mozambique to continue to honor metical-denominated debt.
  • We are therefore affirming our 'SD' (selective default) long- and short-term foreign currency ratings on Mozambique. We are also affirming our 'B-/B' long- and short-term local currency ratings.
  • The outlook on the local currency rating is stable.
RATING ACTION
On Feb. 1, 2019, S&P Global Ratings affirmed its long- and short-term foreign 
currency sovereign credit ratings on Mozambique at 'SD/SD' and its long- and 
short-term local currency sovereign credit ratings at 'B-/B'. The outlook on 
our long-term local currency rating remains stable.


OUTLOOK
Ratings at 'SD' (selective default) or 'D' do not carry an outlook because 
they express a condition (default), and not a forward-looking opinion of 
default probability. The stable outlook on the long-term local currency rating 
reflects our view that the government will continue to honor its 
metical-denominated debt and will not include this debt in its ongoing 
restructuring or exchange offer on its dollar-denominated bond notes. Pressure 
could build on the local currency rating if the government were to include 
metical-denominated debt in any restructuring or exchange offer, perhaps due 
to a worsening in monetary conditions, diminishing the ability of domestic 
banks to absorb local currency debt; or if domestic political conditions 
deteriorated. We do not expect to raise the local currency rating within the 
next year.


RATIONALE
The affirmation of our 'SD' foreign currency ratings stems from Mozambique 
remaining in arrears on its obligations on the US$727 million fixed-rate notes 
issued in April 2016 and maturing in 2023. The government of Mozambique has 
missed coupon payments since January 2017. To proceed with restructuring, we 
understand the terms of the transaction require at least 75% of bondholders to 
agree to a new deal, as well as approvals from the Mozambican parliament. We 
believe negotiation of these two elements may extend into the second half of 
2019, especially since the process is further complicated by legal cases being 
pursued by the U.S. Department of Justice, which alleges misconduct by 
individuals that were involved in the debt transactions. 

In addition to the government's Eurobond arrears, two public enterprises, 
Proindicus and Mozambique Asset Management (MAM), are not current on their 
obligations regarding two loans of US$622 million and US$535 million, 
respectively. Both obligations are reported to be guaranteed by the 
government. We do not rate these loans and we have not been provided with the 
guarantee documentation. We are therefore unable to opine on whether these are 
financial obligations of the guarantor under our criteria, and consequently 
whether the guarantor's failure to honor a payment under the guarantees would 
constitute a default on its financial obligations. 

Once the Eurobond restructuring is completed, we are likely to review the 'SD' 
rating. We will consider raising the foreign currency rating from 'SD' at the 
resolution of the default, that is, once either an exchange or restructuring 
offer has been completed on the Eurobond or we expect no further resolution to 
occur, and we believe a revised rating better reflects our forward-looking 
opinion. 

Institutional and Economic Profile: A lack of transparency in government 
policymaking weighs on institutions and economic growth
  • These governance issues are impeding the resumption of budgetary support from multilateral donors, in our view.
  • Mozambique's wealth levels are low. We expect real GDP growth to accelerate to around 5% in 2020-2022.
In our view, Mozambique's access to external financing and budgetary support 
is restricted because of donor concerns related to the government's weak 
oversight and its lack of transparency and accountability. The International 
Monetary Fund (IMF) suspended its funded program in April 2016 following 
revelations of $1.2 billion (about 10% of 2016 GDP) in hidden bank loans to 
two state-owned companies, MAM and Proindicus, reported to be guaranteed by 
the government of Mozambique. Another funded program is unlikely to be pursued 
in the near term. However, the IMF continues to provide technical support to 
Mozambique and conduct standard Article 4 surveillance. In December 2018, the 
U.S. Department of Justice launched a legal case against individuals who were 
allegedly directly involved in fraud related to $1.2 billion of hidden debt. 
Manuel Chang, former finance minister, and a number of directors from Credit 
Suisse have been arrested in South Africa and the U.K. as the U.S. seeks 
extradition requests for the individuals to be tried in the U.S. courts. 

Frelimo, the ruling party, and the opposing Renamo party agreed to a ceasefire 
in early 2017 after the Renamo military wing's attacks centered in Gorongosa, 
Sofala province over previous years. Since then, the two parties have 
maintained relatively stable relations. However, they have yet to conclude a 
peace deal. Nevertheless, some progress has been made on one of the key causes 
of disagreement between the two parties, administrative decentralization. A 
constitutional amendment was passed in May 2018 allowing provincial governors 
to be elected, rather than appointed by the executive as they previously had 
been, and mayors to be appointed by municipal assemblies rather than directly 
elected. Full implementation of administrative decentralization will be a 
challenge, however, with a lack of clarity on what powers new decentralized 
bodies will have and how the different layers of government will interact. 
Progress on peace talks and integration of the Renamo military wing into the 
official army is likely to be delayed at least until after the October 2019 
presidential and parliamentary elections. Despite the opposition Renamo party 
making inroads in some of the major cities and regions, we think that Frelimo 
will likely retain its majority and form the next government with minimal 
impact on overall government policy. 

We anticipate a modest recovery of economic growth in 2019 (3.8%) and a more 
rapid pick up over 2020-2022, averaging at least 5%. The recovery is led by 
the extractive industries as production of coal, and other minerals, expands, 
while the prices of aluminum and coal stabilize (the latter are among 
Mozambique's major exports). Our higher growth projections for 2020-2022 are 
also associated with mega projects, particularly for gas sector companies. For 
example, Anadarko, the U.S. energy company leading a consortium developing the 
onshore Area 1 liquefied natural gas (LNG) project, announced at the end of 
June 2018 that it is ready to move forward with the $25 billion Mozambique 
project after lining up enough customers for the LNG it plans to produce. The 
company expects to reach a final investment decision in the first half of 
2019. The Anadarko developments follow the financial close of another sizable 
offshore project led by Italian oil major ENI. Although LNG projects will 
significantly improve Mozambique's export mix and boost its economy once 
completed, they will take time to make a full contribution to the economy, and 
most benefits will materialize beyond our forecast horizon.

In the interim, a particularly heavy government debt burden, coupled with weak 
domestic demand and low investment levels, will continue to weigh on 
Mozambique's economic prospects. Our economic assessment on Mozambique also 
remains constrained by very low GDP per capita on a global basis at less than 
US$500 in 2019.

Flexibility and Performance Profile: Large current account deficit and fiscal 
pressures will remain until significant LNG projects come on stream
  • Exports increased in 2018, helping to maintain the current account deficit (CAD) at about 20% of GDP, similar to 2017. However, we expect a widening of CADs in 2019-2022 when imports related to LNG projects increase.
  • Expenditure will likely increase in the run-up to the election period, making it unlikely that the government will consolidate the fiscal position in the near term. The government debt burden will remain very high.
In 2018, Mozambique's sizable CAD remained close to 20% of GDP, driven by the 
structurally high deficit on the services balance. The goods balance is also 
in deficit but to a much smaller degree, with exports more closely aligned 
with imports. In our view, large projects such as those in the coal industry 
generate high levels of foreign direct investment in the country (16% of GDP) 
in 2018, which subsequently drive import demand and the large CADs. 

Over 2019-2022, we expect that while coal prices will remain flat, capital 
goods and service imports related to higher economic activity and mega 
projects are likely to increase. Increased activity tied to LNG projects is 
likely to widen the country's CAD to about 30% of GDP by 2022. Although LNG 
projects will ultimately bring benefits, they entail short- and medium-term 
risks. We project that Mozambique's net external liabilities as a share of 
current account receipts will average over 700% in 2019-2022, and that gross 
external financing needs as a share of current account receipts plus usable 
reserves will average just below 150% over the same period. While the external 
position is still very weak, we note that the central bank of Mozambique has 
been able to increase its foreign currency reserves in 2018 from below three 
months coverage of current account payments (CAPs) in 2017 to closer to four 
months' cover in 2018. Given the still prevailing CADs, we expect to see some 
mild downward pressure but with CAPs coverage remaining close to three months 
by 2022. While Mozambique is still working on improving governance, 
transparency, and accountability, external funding to the government remains 
limited until donor requirements are met. Our analysis of external and fiscal 
data is hampered by lack of comprehensive data. Fiscal and external debt 
statistics are revised frequently with material changes. However, the IMF 
technical missions are working with the government to improve quality of 
reporting and statistics.  

Mozambique is a low-income economy requiring the government to cover 
shortfalls in basic services and infrastructure, constraining already limited 
fiscal revenues. Ahead of the October 2019 elections and given recurrent 
expenditure pressures, we estimate fiscal deficits will weaken to 8% of GDP in 
2019. We think that the economic recovery is likely to provide a boost to 
government revenues, while constrained access to external financing could 
limit capital spending, resulting in a mild narrowing of the budget deficit 
over 2020-2022. However, we project that net debt will accumulate, expanding 
by 12% of GDP on average over 2019-2022 as a result of off-budget spending and 
exchange rate depreciation. We estimate that over 80% of the government's debt 
stock is in foreign currency and the vast majority of commercial debt is held 
by nonresidents. We also estimate that net general government debt will remain 
over 100% of GDP though 2022 and interest to revenue will remain above 10%. We 
expect the government's very high annual financing needs to be met by some 
bilateral project-related external funding, but for the most part to be 
financed in local currency by domestic banks, who have excess liquidity due to 
the repayment of past loans and lack of new lending opportunities. 

The bank of Mozambique pursues a managed floating exchange rate system, in our 
view. The metical's appreciation by close to 6% against the U.S. dollar in 
2018 and the normalization of food prices has dampened inflation, which 
remained below 5% over most of 2018 after climbing to a high of 26% in 
November 2016. In response, the central bank of Mozambique has been in an 
easing cycle, using its policy rates. Domestic private sector credit growth is 
still weak since bank lending remains conservative while banks repair balance 
sheets weakened by large nonperforming loans and keep lending rates high. In 
our view, the weak credit growth trends also weaken the transmission of 
monetary policy to the banking sector and the real economy. As a result, we 
view the monetary policy transmission mechanism as weak.