Fitch Ratings, on Thursday, downgraded Tunisia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘B-‘ from ‘B’. The Outlook is Negative.
The downgrade to ‘B-‘ and Negative Outlook reflect heightened fiscal and external liquidity risks in the context of further delays in agreeing on a new program with the IMF, which is necessary for access to most official creditors’ budget support.
The fragmented political landscape and entrenched social opposition curtail the government’s ability to enact strong fiscal consolidation measures, complicating efforts to secure the IMF program.
In the absence of strong reforms, official creditors might consider a debt restructuring necessary before additional support can be extended. The government has firmly stated that it is not considering a debt restructuring and Tunisia has never engaged in a Paris Club treatment.
Fitch forecasts the central government deficit to remain high at 8.9% of GDP in 2021, compared with 9.9% in 2020 and the ‘B’ category median of 6.2%. it projects revenues will recover in 2021, but this will be largely offset by higher spending to combat the pandemic, rising gas price subsidies, a growing interest burden and increases in the wage bill following an agreement with unions in 2019. The latter two items will absorb close to 75% of revenues, significantly constraining fiscal flexibility.
The recent surge in Covid-19 infections adds to downside risks for revenues. The rating agency forecasts the budget deficit to narrow to 6.7% of GDP in 2022 and 5.5% in 2023 as pandemic-related spending is phased out and some spending cuts are implemented, but the wage bill remains above its pre-2019 level as a share of GDP. In May 2021, trade unions rejected a government plan to trim the wage bill mostly through attrition and voluntary departures.
Funding needs from large fiscal deficits and debt amortization are high compared with identified sources. Government debt maturities will stand between 7.3% and 9.2% of GDP over 2021-23, including between 3.2% and 5.1% in external amortization.
An agreement on a successor IMF arrangement to the program that expired in 2020 remains key for Tunisia’s external financing. Although commitment of external official creditors to help Tunisia’s democratic transition and contain migration flows across the Mediterranean remains strong, many partners’ financial support is linked to an IMF agreement.
Uncertainty on reaching agreement with the IMF
The rating agency stresses that its forecast assumes agreement on an IMF program before end-2021 but continued strong social opposition to fiscal reforms and the fragility of parliamentary support for the government mean an agreement may not be reached and highlights challenges in maintaining scheduled disbursements. Tunisia’s performance under the previous two arrangements with the IMF has been weak, with reviews during the last program suffering consistently large delays.
In February, the IMF judged Tunisia’s debt “would become unsustainable unless a strong and credible reform program were adopted with broad support”. In a no-reform scenario, Tunisia may ultimately be deemed to require a Paris Club treatment before being eligible for additional IMF funding, with implications for private-sector creditors.
The authorities are increasingly relying on domestic financing as Tunisia struggles to roll over external maturities. Tunisia compensated near-zero net external funding in 2020 by raising a record net 7.3% of GDP from domestic sources. This compares with a total domestic debt stock of 21% of GDP at-end 2019, half of which was held by the banking sector. Tunisia resorted to direct monetary financing from the central bank for the first time last year, despite the central bank’s objections, highlighting funding tensions.
Planned access to international markets (2.2% of GDP in 2021) would be complicated by the absence of an IMF program. Two US government guaranteed bonds of USD500 million each will mature at the end of July and early August 2021. A new US guarantee for international issuance is being discussed, but in Fitch’s view it is unlikely to materialize before 4Q21 and may be linked to successful IMF negotiations.
Bilateral funding has been forthcoming in the first half of the year, but the amounts remain modest, with 1.2% of GDP disbursed by European counterparts. The authorities also raised 1.2% of GDP in foreign currency from syndicated loans with local banks.
According to Fitch, a failure to agree with the IMF and to access international financial markets, resulting in continued heavy reliance on domestic funding, would put pressure on external buffers.
This is in the context of external public debt amortization (4% of GDP per year on average over 2021-23), large current account deficits (8% per year) and modest net FDI inflows. FX reserves dropped to USD8.1 billion at end-May 2021, down from about USD9.4 billion at end-2020.
Current account deficit close to 8% of GDP
Fitch expects Tunisia’s current account deficit to widen in 2021 to close to 8% of GDP and remain at this level in the medium term, from 6.8% in 2020.
Remittances from Tunisian workers abroad surged in 2020 and will remain an important source of FX. We expect the services balance to be close to zero in 2021 as the current wave of infections deters international tourism during the peak season. The rating agency said it projects external debt to rise to 83% of GDP in 2023 from 77% in 2021, propelled by the resumption of public external borrowing.
Given high fiscal deficits, general government (GG) debt will rise to 89% of GDP in 2021, from 72% in 2019, and continue to rise to 93% by 2023, well above the forecast ‘B’ median of 70%. Significant contingent liabilities from financially weak SOEs and the banking sector pose upside risks to the debt trajectory. GG-guaranteed SOE debt is high, at 16% of GDP, half of which is at the ailing electricity company, STEG. Transfers to troubled SOEs are a drain on the budget and the IMF estimates that the government had arrears of about 8% of GDP to SOEs as of mid-2020, although part of these were cleared and SOEs also have substantial arrears towards the state. The government plans to advance restructuring of a host of SOEs but this is not factored into the fiscal projections. Transparency on SOE financial health metrics is low.
Fitch forecasts Tunisia’s economy to grow by 3.4% in 2021 after a contraction of 8.8% in 2020 and below the ‘B’ median of 4.2%. This reflects poor agricultural output due to unfavorable weather conditions, a rebound of exports of goods to Europe and a moderate uptick in tourism in late 2021.
The recent surge in Covid-19 infections and associated containment measures raise downside risks to the forecast for growth and could also negatively affect public and external finances. After a rebound to 4% in 2022, we expect growth in 2023 to normalize to a rate closer to trend, at around 2%.
Public banks account for one-third of the banking sector’s assets, have weaker asset quality and capitalization metrics than their private sector peers and may require capital injections from the sovereign in the medium term. The broad banking sector’s health metrics are weaker than ‘B’ medians, with a high proportion of non-performing loans (13.6% of total loans at end-2020). Asset quality is likely to deteriorate as forbearance measures expire, Fitch says in conclusion.
