OREANDA-NEWS. Fitch Ratings has affirmed Seychelles' Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'B+' and 'BB-' respectively. The Outlooks are Stable. The issue ratings on Seychelles' unsecured foreign currency bonds have also been affirmed at 'B+'. The Country Ceiling has been affirmed at 'B+' and the Short-term foreign currency IDR at 'B'.

KEY RATING DRIVERS
The affirmation and the Stable Outlook reflect the following key rating drivers:

The rating balances Seychelles' recent default history, fairly high public debt burden, a large current account deficit and limited economic diversification against high level of GDP per capita and standards of governance.

The current account deficit widened to an estimated 22% of GDP in 2014, from 15.5% in 2013, albeit primarily financed by foreign direct investment (FDI). Imports rose sharply owing to a marked increase in public sector wages, an acceleration in private sector credit growth (to over 10% yoy in July 2014) on the back of government programmes to support lending to households and SMEs, and higher FDI. At the same time, foreign currency earnings weakened as tourism arrivals declined (1% yoy as of September 2014) and tuna exports fell.

The current account deterioration resulted in a sharp depreciation of the Seychelles rupee (SCR) against the USD and the EUR, despite the central bank tightening monetary policy. The central bank increased Treasury-bill issuance, leading to a decline in reserve money by 6.7% yoy in September 2014 and higher interest rates. In addition, the authorities tightened the eligibility requirements for the government's SME lending programme.

Monetary policy tightening negatively affected economic activity. Real GDP growth is likely to have slowed to 2.8% in 2014 from 5.3% in 2013, below the projection of 3.7% in our August 2014 rating review. We forecast real GDP growth of 3% in 2015, in line with the IMF's and the Ministry of Finance's projections. With policy likely to remain tight, GDP growth this year will depend on the performance of the tourism sector which is, however, hampered by a lack of direct flights to Europe.

In Fitch's view, balance of payment pressures should gradually ease in 2015 as the monetary tightening, a freeze in public sector wages (which will feed through to private sector wage negotiations), and lower commodity prices cut the import bill. Recent figures suggest that import growth has already started to ease in 3Q14.

Despite a large current account deficit, Seychelles has been able to build foreign exchange reserves in line with IMF targets since the 2008 balance-of-payments crisis. This reflects its ability to attract large FDI flows (18% of GDP on average since 2008) into the tourism and hotel sector. The Central Bank of Seychelles took advantage of the favorable balance of payment backdrop in early 2014 to purchase USD24m more than planned, taking gross FX reserves to USD464m (33% of GDP) in December 2014. Increasing reserves is important for improving confidence in the currency, given the large current account deficit, and for providing a buffer to meet public external debt service, which has been rising since 2013.

Inflationary pressures have been contained despite the depreciation of the exchange rate. In December 2014, inflation declined to 1.4%, from 4.3% a year earlier. Lower oil and other commodity prices have helped in this respect; electricity prices are declining. Fierce competition in the tourism sector has also driven down prices in the sector.

General government debt was fairly high at 61.3% of GDP at end-2014, compared with the 'B' median of 46.5%. Fiscal performance was strong in 2014 as revenues outperformed relative to budget, mainly owing to strong import duty receipts. Fitch estimates a primary surplus at SCR754m (4.1% of GDP) for 2014. However, exchange rate depreciation meant the government debt/GDP ratio was little changed in 2014, despite the large primary surplus, as 63% of government debt is denominated in foreign currencies.

Given the weaker currency and higher interest payments the authorities have decided to increase the primary surplus targets for 2015 and 2016 to meet the goal of reducing public debt below 50% of GDP by 2018. Fitch projects primary surpluses of 4.2% of GDP in 2015 and 2016, and for public debt to gradually decline to 52.4% of GDP by 2016.

The Central Bank of Seychelles and the Ministry of Finance have decided to issue medium-term Treasury bonds (2-5 years), supplemented if necessary by Treasury bills. The establishment of a yield curve and a money market at longer maturities should improve the depth of the financial markets. Fitch expects financial stability will benefit from on-going reforms to the liquidity management framework.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently well-balanced. However, the main factors that could lead to a positive rating action are:
- A reduction in external vulnerability through a narrowing in the current account deficit and accumulation of foreign exchange reserves
-Continued reduction in public-sector debt in line with the government's medium-term fiscal plan
-Establishing a track record of moderate inflation and greater confidence in the flexible exchange rate regime to absorb shocks without threatening price and financial stability
-Sustained GDP growth, particularly if underpinned by continuing structural reforms, to improve the business environment and diversify the economy

The main factors that could lead to a negative rating action are:
- Balance of payment pressures leading to falls in foreign exchange reserves and increases in external debt ratios
- A prolonged period of macroeconomic instability
- Deterioration in the general government balance, for example, caused by relaxation of expenditure control or unexpected expenditures related to the state-owned enterprises

KEY ASSUMPTIONS
The ratings are based on the assumption as follows:

Despite recent diversification, Seychelles' main tourism market remains Europe, and especially eurozone countries (France and Germany). Fitch expects eurozone growth to gradually recover to 1.1% in 2015 from 0.8% in 2014.

Seychelles' current account payments are dependent on commodity prices, and especially oil. Fitch has revised its forecast for oil prices to USD70-80/barrel in 2015 and 2016, from USD95-USD108 at the time of the previous rating review in August 2014.

Fitch's current judgement is that the authorities will continue to maintain fiscal discipline in a way consistent with their debt reduction targets.