Fitch revises Dominican Republic’s outlook to positive; affirms ‘B+’ ratings
New ork–(Business Wire)–Fitch Ratings has affirmed the Dominican Republic’s long-term foreignand local currency Issuer Default Ratings (IDRs) at ‘B+’. The Rating Outlookson the long-term IDRs are revised to Positive from Stable. The issue ratings onthe Dominican Republic’s senior unsecured foreign and local currency bonds areaffirmed at ‘B+’. The Country Ceiling is affirmed at ‘BB-‘ and the short-termforeign currency IDR at ‘B’.
KEY RATING DRIVERS
The Positive Outlook onthe Dominican Republic’s long-term IDRs reflects the continued positiveeconomic performance relative to peers, the reduction of external vulnerabilities,and progress on gradual fiscal consolidation.
The Dominicanservices-based economy has surpassed previous growth expectations and isexpected to remain robust at 5.1% for 2016-2017. Diversification into tourism,higher value manufacturing, and recently mining has supported the economy’sresilience through economic cycles. In 2015, Fitch expects robust 6.2%demand-led growth. The wealth effect of the low oil price plus externalreceipts stimulate private consumption, complemented by the expansionary fiscalstance. Private housing and tourism investment has spurred construction alongwith government investment in two coal plants. This high growth is achievedwithout evidence of macroeconomic imbalances.
Inflation has declinedand is expected to average 2.4% and 3.2% in 2015 and 2016, respectively, drivenby the low oil price. Relative exchange rate stability supports the convergenceof inflation expectations toward the midpoint of central bank’s 4%+/-1% targetband. Challenges to consolidating the inflation-targeting regime introduced in2012 include central bank operational losses, rapid imported-price pass-through,and financial dollarization.
Fitch expects thecurrent external deficit will narrow to 2.3% of GDP on average for 2015-2017and 1.1% of GDP average surplus after net FDI. While the low oil price isexpected to endure, external accounts’ sensitivity to international oil pricescould decline over the medium term as the electricity sector substitutes coaland renewable power. CXR growth is supported by U.S. demand for tourism andmanufactured exports and remittance transfers. FDI averaging 4% of GDP per yearover 2015-2017 is expected into tourism, telecoms, and manufacturing. Externalfinancing needs have narrowed close to 80% of international reserves for2015-2017, down from over 100% in recent years.
The DominicanRepublic’s external balance sheet remains vulnerable with limited buffers. Thesovereign has a large net external debtor position with 70% of public debtdenominated in foreign currency. The stable exchange regime has limited shockabsorptive capacity. External liquidity is weaker than ‘BB’ and ‘B’ peers, asliquid external assets cover less than 100% of maturing external liabilitiesand increased non-resident capital market participation. These factors arebalanced by the expected favourable trends in the balance of payments and lowercommodity dependence than ‘B’ peers.
Fitch expects thegeneral government will render a 2.6% of GDP deficit in 2015. The government isusing oil-price savings to bring an estimated 0.4%-of-GDP of power plantinvestment on budget in 2015 while meeting its primary surplus objective.
In addition to thegovernment’s 2016 deficit target, Fitch incorporates 1.2% of GDP power plantinvestment in the 3.6% of GDP overall general government deficit forecast for2016, reflecting half the remaining capital investment (for 2016-2017) forwhich the legislature approved financing in 2015. Renewed international capitalmarket access since 2010, development of the domestic yield curve since2009–both supported with active debt management–and multilateral creditsprovide the government financing flexibility.
Public financeweaknesses place government debt on a sustained upward trajectory. Althoughgeneral government debt is currently lower than peers, Fitch expects it willrise to 39% of GDP in 2017. Faster fiscal consolidation is hindered by the narrowtax base, rigid wages and salaries, and rising non-discretionary expenditurefrom electricity-sector transfers and interest bill–20% of revenue in2015–from financial losses of the central bank and electricity generators.
The risk of materialfiscal slippage repeating in the 2016 electoral cycle appears to have lessened,in Fitch’s view. While the proposed fiscal pact has not yet materialized,several factors signal likely fiscal restraint, including the expected primaryfiscal surplus in 2015, limited pipeline of infrastructure projects, andbuoyant economy. President Danilo Medina (PLD) has strong approval ratings butthe long election cycle could turn competitive in the months ahead. Thegoverning PLD has struck an alliance with the PRD forming a large electionblock for the May 15, 2016 polls and secured congressional passage of aconstitutional amendment restoring consecutive presidential terms. Electricitysector reform is likely to remain atop the policy agenda in 2016-2017.
The Dominican Republic’sratings are further underpinned by the country’s higher per capita income andsocial indicators than peers, its service-based economy, and improving debtmanagement. These credit strengths are balanced by the weak structure of publicfinances, large net sovereign external debtor position with limited externalbuffers, and shallow albeit developing domestic capital market.
The main factors,individually or collectively, that could lead to a positive rating action are:
–Continued stronginvestment and growth performance relative to peers without increasingmacroeconomic imbalances;
–Sustained fiscaldiscipline that enhances the credibility of fiscal policy;
–Reduction of externalbalance sheet vulnerabilities;
The rating Outlooks arePositive. The main factors that could see the ratings revert to a StableOutlook are:
–Fiscal slippage orgrowth underperformance leading to a material increase in government debtburden;
–Deterioration ofexternal liquidity or increased macroeconomic imbalances;
–Emergence offinancing constraints.
The ratings andOutlooks are sensitive to a number of assumptions:
–Fitch forecasts thataverage U.S. growth of 2.4% in 2015-2017 will support the Dominican Republic’seconomic growth and external accounts, given the strong trade and financiallinkages between the two countries.
–The DominicanRepublic’s fiscal and external forecasts assume that annual gold production issustained at 1 million ounces and international prices average USD1075 perounce in 2016-2017, benefiting exports and mining royalties. Fitch’s latestprojections also factor in adjustment of the average Brent oil price to USD55per barrel in 2015 and USD60 in 2016, maintaining reductions of the country’sfuel import bill and electricity transfers.
–Fitch assumes thatthe normalization of monetary policy rates in the U.S. proceeds in an orderlymanner and there are no large capital outflows or external market financingconstraints for the Dominican Republic in 2015-2017.
Additionalinformation is available on www.fitchratings.com