Moody's downgrades Mozambique issuer rating to B3, maintains the review for downgrade

Moody's has today downgraded Mozambique's issuer rating to B3 from B2, maintaining the rating on review for downgrade. This extends the review for downgrade of Mozambique's sovereign rating initiated on 17 December 2015.

The key driver for the rating downgrade is Mozambique's deteriorating balance of payments position and reduced capacity for the government to service its outstanding debt, as evidenced by declining foreign exchange reserves of the Bank of Mozambique and the government's decision to initiate a debt exchange offer to reduce the drain on foreign exchange reserves in coming years.

The continuing review for downgrade will allow Moody's to assess the implications of the proposed debt exchange on the government's willingness and capacity to service its debt obligations. The EMATUM notes exchange proposal, announced on 9 March 2016, will likely constitute a distressed exchange according to Moody's definition. Moody's will also assess the potential severity of the pressures on Mozambique's balance of payments and the reserve position of the Bank of Mozambique in the absence of a permanent liquidity backstop.

Concurrently, Moody's lowered Mozambique's foreign-currency deposit ceiling to Caa1 from B3, and local-currency bond and deposit ceilings to B1 from Ba3.The foreign-currency bond ceiling remains unchanged at B1.

RATINGS RATIONALE

RATIONALE FOR THE RATING DOWNGRADE TO B3

Moody's decision to downgrade the issuer rating of the government of Mozambique primarily reflects pressures on Mozambique's balance of payments and the further decrease expected in the Bank of Mozambique's foreign exchange reserves.

The Bank of Mozambique's foreign exchange reserves were $2.3 billion at the end of 2015, down from their peak level of $3.2 billion reached in August 2014. Strong pressures on the foreign exchange reserves developed in mid-2014 and ultimately led to the provision of $285 million short-term funding by the IMF in December 2015, of which $120 million was immediately disbursed to help cover the widening external financing gap. Pressures came primarily from low commodity prices and fast growing imports -- related to general consumption only, not to mega-projects -- which grew 8% in dollar terms over the first three quarters of 2015 compared to the same period in 2014. Bank of Mozambique intervention in the foreign exchange market at the end of 2014 and in early 2015 to support the Mozambican Metical also weighed on foreign exchange reserves and likely slowed imports adjustment.

Moody's believes that foreign exchanges reserves will continue to fall in 2016, despite the expected disbursement of the remaining $165 million under the IMF's Short Term Credit Facility, lower government external debt service following the debt exchange and the expected contraction in imports. Subdued commodity prices, delays in foreign megaprojects, including in the Liquefied Natural Gas (LNG) sector, will continue to weigh on the balance of payments going forward.

While projects in the LNG sector remain profitable despite low oil and gas prices -- according to most specialists, this is because of the quality of the gas reserve in Mozambique -- the capacity of companies in the sector to finance such large projects has been impaired. As such, delays in the projects are likely. Anadarko, one of the two companies leading projects in the Mozambican sector, had its rating downgraded by Moody's on 18 February 2016 to Ba1 with a negative outlook to reflect increasing financial pressures which are also likely to affect its development plans in Mozambique, at least over the near term.

Moody's notes that on the policy front, key steps have been taken under the umbrella of the Policy Support Instrument Programme/Short Term Credit Facility with the IMF. A reform of the foreign exchange market is under way. Regulated prices for water, electricity, bread were increased at the end of 2015, though not without collateral damage on inflation -- which had risen to 11.5% by the end of the year. The Bank of Mozambique has increased its policy rates, three times at the end of 2015 and once again in February 2016, and also raised the reserve requirement for banks in 2015 with the pass through to the cost of government domestic debt being limited.

However, while these key policy steps will support an adjustment in the balance of payments, in the absence of a permanent liquidity backstop they have not removed the pressures on Mozambique's balance of payments arising from the particularly adverse external environment.

On 9 March 2016, the government offered to exchange notes issued by a special purpose vehicle of the Mozambican fishing company, Mozambique EMATUM Finance 2020 B.V. (Caa2 review for downgrade), on terms that Moody's will likely view as amounting to a distressed exchange. The EMATUM debt takes the form of a $850 million in loan participation notes, of which $697 million is currently outstanding, and which benefits from the irrevocable guarantee of the government. Payments of almost $200 million per annum are due under the EMATUM bond's amortising structure, further pressuring Mozambique's dwindling foreign exchange reserves.

Moody's views EMATUM's obligations as a liability of the Mozambican government. Last year, out of the $850 million originally issued by the SPV, $350 million remained on the company's balance sheet, while the government of Mozambique recognised $500 million on its own balance sheet as these proceeds served to finance government expenditures related to maritime security. The EMATUM company, which is responsible for the servicing of 41% of the debt, has been and remains in a precarious financial position.

RATIONALE FOR THE REVIEW FOR FURTHER DOWNGRADE

The review will allow Moody's to assess the implications of the proposed debt exchange for the government's willingness and capacity to service its debt obligations. The presence of the irrevocable government guarantee means that Moody's would consider a default on the notes, including via a distressed exchange, to be a default by the government. Apparent willingness to default on a debt-related obligation is a factor that Moody's needs to take into account in its assessment of the government's willingness and capacity to service its continuing debt obligations.

Moody's will also assess whether pressures on the balance of payments and the reserve position of the Bank of Mozambique are more severe than currently projected. The outcome of the EMATUM debt exchange will be relevant to this assessment. While the exchange will likely provide some relief against rising pressures, it could also exacerbate balance of payments pressures, for example by reducing inward FDI flows.

WHAT COULD CHANGE THE RATING DOWN

The rating would likely be downgraded further should Moody's conclude that the proposed EMATUM exchange indicates a lower willingness to service outstanding debt than is consistent with a rating in the 'B' category.

Evidence of greater than expected disruption to the balance of payments and diminution in reserves, whether because of the outcome of the EMATUM exchange or for any other reason, would also be credit negative.

Any further downward adjustment to the government of Mozambique issuer rating would most likely be limited to one notch.

WHAT COULD CHANGE THE RATING UP

An upgrade to the issuer rating is unlikely. The rating might be stabilised were the review to suggest that government policy would move in a direction which emphasised the government's continued willingness to service its obligations, and to support the economy's external adjustment in a manner which conserves foreign currency buffers.

GDP per capita (PPP basis, US$): 1,178 (2014 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 6.3% (2015 Estimate) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 5% (2015 Estimate)

Gen. Gov. Financial Balance/GDP: -6% (2015 Estimate) (also known as Fiscal Balance)

Current Account Balance/GDP: -37.2% (2015 Estimate) (also known as External Balance)

External debt/GDP: 92.8% (2015 Estimate)

Level of economic development: Very Low level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 14 March 2016, a rating committee was called to discuss the rating of the government of Mozambique. The main points raised during the discussion were: The issuer has become increasingly susceptible to event risks, Increased pressures on balance of payments and the resulting decrease in reserve levels, Discussion on the upcoming EMATUM notes exchange.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.