Dominican Republic IDRs upgraded by Fitch to ‘BB-‘
New York.–(BUSINESS WIRE)–Fitch Ratingshas taken the following rating actions on the Dominican Republic:
–Long-Term Foreign Currency Issuer DefaultRating (IDR) upgraded to ‘BB-‘ from ‘B+’; assigned Stable Outlook;
–Long-Term Local Currency IDR upgraded to’BB-‘ from ‘B+’; assigned Stable Outlook;
–Senior unsecured Foreign and LocalCurrency bonds upgraded to ‘BB-‘ from ‘B+’;
–Short-Term Foreign Currency IDR affirmedat ‘B’;
–Short-Term Local Currency IDR affirmed at’B’;
–Country Ceiling affirmed at ‘BB-‘.
KEY RATING DRIVERS
The upgrade of the Dominican Republic to’BB-‘ reflects its continued strong growth momentum and rising per capitaincome, reduced external vulnerabilities and fiscal restraint through the 2016election cycle.
High economic growth rates have raisedDominican Republic’s per capita GDP to USD6,734, greater than the ‘BB’ median.Fitch expects the economy to expand 6.7% in 2016 supported by strong domesticdemand and external receipts of tourism and remittances. Growth could slow to5.5% in 2017 (albeit still higher than the peer median) driven by higher oilprices, higher-cost external financing conditions, and tighter monetary stance.
External imbalances have been progressivelyreducing in recent years, mainly reflecting lower oil prices. Fitch expects theDominican Republic to sustain low current account deficits (CAD) of 1.7% and2.1% of GDP in 2016 and 2017, respectively, financed sustainably by net foreigndirect investment (FDI). Tourism, remittances, and gold exports support thegrowth in current external receipts (CXR). Slowly rising oil prices areforecast to gradually widen the CAD, but this effect will be tempered as thenew coal plants begin operating in 2018 and substitute coal for diesel imports.
The governing PLD party demonstrated fiscalrestraint through the 2016 election, in which President Danilo Medina won a secondterm with a congressional majority, supporting policy continuity. Higherspending during the previous 2012 election year resulted in the widening of thefiscal deficit to 5.3% of GDP from 2.5% in 2011. Fitch expects the governmentto register a 3% of GDP deficit in 2016, in line with the government’s trend ofmoderate fiscal deficits since 2013. In 2016, the government is offsettinglower-than-budgeted revenues with lower electricity subsidy and otherexpenditure reductions while extra-budgetary public coal-plant investments willadd 0.6% of GDP to capital expenditure.
Fitch expects a similar general governmentdeficit at 3.1% of GDP in 2017. The government started in 2H16 to implement taxadministration measures to capture +0.6pp GDP in new revenues in 2017. Thegovernment could run a small primary surplus in 2018, supported by lowerelectricity-subsidy and capital spending. The government has postponed theintroduction of a tax reform until at least 2017 after the tax-administrationmeasures are implemented. The tax-reform delay and limited progress on theelectricity pact reform highlights slower reform momentum.
Dominican Republic’s general governmentdebt, expected to reach 36.7% of GDP in 2016, is lower than the ‘BB’ median,but the government’s low tax base points to weaker debt tolerance than ‘BB’peers. General government debt-to-revenues exceeds 250% whileinterest-to-revenues is high at 20%. Continued quasi-fiscal electricity-sectorlosses are likely to prevent the government debt burden from stabilizing.However, the government financing flexibility is supported by its access tointernational capital markets, multilateral borrowing, and the developingdomestic bond market.
Inflation remains subdued at 0.9% yoy aswell as core inflation at 1.8% yoy. Oil prices are expected to contribute to apick-up in 2017. An inflation-targeting regime adopted in 2012 is still takingroot, and inflation expectations remain anchored to the DOP/USD exchange rate.The central bank raised the monetary policy rate 50bps to 5.5% effective Nov. 1to address the positive output gap, expected U.S. monetary tightening, anduncertainty arising from U.S. trade policy.
The financial system remains broadly stablewith a moderate level of financial dollarization. Commercial banks’ creditportfolios do not show signs of stress, with low NPLs at 1.8%, andcapitalization ratios are adequate at 15.4%. However, real credit growth hasbeen high in recent years, averaging around 13% for 2013-15.
Dominican Republic’s external balance sheetis weaker than ‘BB’ peers. Sustained external borrowing is raising thesovereign’s net foreign debt toward 18.2% of GDP in 2016 while total externaldebt service also surpasses the ‘BB’ median. The country’s internationalreserves, USD5.5bn, have risen although Fitch’s international liquidity ratiofor Dominican Republic remains below 100%, reflecting its vulnerability toexternal shocks.
Downside risks to growth and external accountscould emerge in case of a shift in trade and immigration related policies underthe administration of U.S. President-elect Donald Trump. The Dominican Republichas extensive trade (through CAFTA-DR) and financial ties with the U.S.
The U.S. represents 36.6% of tourist airarrivals, receives half of Dominican Republic’s merchandize exports, andcontributes 5.3% of GDP in workers’ remittances (2015).
SOVEREIGN RATING MODEL (SRM) andQUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns the DominicanRepublic a score equivalent to a rating of ‘BB+’ on the Long-term FC IDR scale.Fitch’s sovereign rating committee adjusted the output from the SRM to arriveat the final LT FC IDR by applying its QO, relative to rated peers, as follows:
–Public finances: -1 notch, to reflectrisks to the Dominican Republic’s limited budget flexibility, constrained bythe narrow tax base, rising interest bill and current expenditure rigidities.The quasi-fiscal losses of the electricity sector continue to put pressure onthe government’s debt dynamics. Recapitalization of the central bank remains acontingent liability for the sovereign.
–External finances: -1 notch, to reflectthe Dominican Republic’s weaker external liquidity position and vulnerabilityto external shocks.
Fitch’s SRM is the agency’s proprietarymultiple regression rating model that employs 18 variables based on three yearcentered averages, including one year of forecasts, to produce a scoreequivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitativeframework designed to allow for adjustment to the SRM output to assign thefinal rating, reflecting factors within our criteria that are not fullyquantifiable and/or not fully reflected in the SRM.
The Outlook is Stable. The main factorsthat, individually or collectively, could lead to a positive rating action are:
–Strengthened international reservesposition;
–Strengthening of the government’s revenuebase, fiscal consolidation and reduction of public debt burden.
The main factors that could lead to anegative rating action are:
–Increased budget deficits and/or weakergrowth leading to a marked increase in the government debt burden;
–Deterioration of the internationalreserves position and current account deficit;
–Emergence of fiscal financingconstraints.
The ratings and Outlooks are sensitive to anumber of assumptions:
–Fitch forecasts that U.S. growth of 1.4%,2%, and 2.2% in 2016, 2017, and 2018 respectively will support the DominicanRepublic’s economic growth and external finances.
–Fitch’s fiscal and external forecastsassume that annual gold production is sustained at 1 million ounces andinternational prices average USD1,100 per ounce in 2016-2018. Further, theyassume a gradual rise of the average Brent oil price from USD42 per barrel (bp)in 2016 to USD55 pb in 2018.