OREANDA-NEWS. Fitch Ratings has downgraded the Republic of Congo's Long-term foreign and local currency Issuer Default Ratings (IDR) to 'B' from 'B+'. The Outlooks are Negative. The issue ratings on the country' senior unsecured foreign currency bonds have also been downgraded to 'B' from 'B+'. The Country Ceiling has been affirmed at 'BBB-' and the Short-term foreign currency IDR at 'B'.

KEY RATING DRIVERS
The downgrade of the Republic of Congo's IDRs reflects the depleting sovereign and external assets due to a rapid deterioration in fiscal accounts resulting from the sharp fall in oil prices since 2014 and the lack of a policy response. The Negative Outlook reflects uncertainties around the financing options for the budget deficit in the context of a high-spending 2016 budget.

More specifically, it reflects the following key rating drivers and their relative weights:

HIGH
The Republic of Congo's budget deficit ballooned in 2015, to around 10% of GDP according to government's official figures, and closer to 18% of GDP based on the use of financing sources, much higher than the 2015 'B' medians of 4.1%. This reflects the drastic fall in oil receipts (which accounted for 75% of budget revenues in 2010-2014) following the drop in oil prices and the temporary decline in oil production. It also reflects the continuation of the massive public investment policy (with capital spending of around 16% of GDP) to finalise infrastructure of the September 2015 All African Games and ahead of the March 2016 presidential election.

While Fitch expects average oil prices of USD35/bbl this year, the current 2016 budget envisages a 15% increase in wages and in domestically-financed capital spending from the 2015 level, raising doubts on the willingness of the government to consolidate fiscal accounts. Fitch estimates that the budget deficit is likely to remain in the double digits in 2016 at 13.4% of GDP. This forecast is based on the assumption that a revised budget incorporating lower capital spending is passed after the elections.

The government has eroded its fiscal and external buffers by heavily drawing on deposits at the central bank and at the EximBank of China, as well as on central bank statutory advances, in order to finance the budget deficit in 2015. With total deposits nearly halving in 2015 in nominal terms to around 17% of GDP and rising external debt contracted from bilateral creditors (mostly Chinese), Fitch estimates that the public sector became a net debtor in 2015 for the first time since the 2010 HIPC debt cancellation.

Financing options are narrowing, as the government has reached its ceiling of central bank advances and as tapping remaining deposits would leave it unarmed to face future shocks, including a lower than expected recovery in oil prices. Fitch therefore assumes that the government will resort to borrowing from the regional bond market and from official creditors this year, pushing public debt to around 50% of GDP by end-2016, 7ppt higher than envisaged in our previous review. Although the country's public external debt is largely concessional, rising domestic public debt will gradually increase the total cost, which is currently much lower than the 'B' medians.

MEDIUM
The downward revision of the oil price assumption for 2016 and 2017 implies weaker external finance metrics than in our previous review (oil accounted for 88% of goods exports in 2010-2014). The current account deficit probably exceeded 14% of GDP in 2015. Despite the continuation of large FDI in the hydrocarbon industry, international reserves have declined since end-2014. Total reserves at the regional central bank (accumulated by the six member states of the CEMAC) declined by 22% over the first eight months of the year, largely reflecting drawdowns of reserves by the Republic of Congo. We therefore now estimate that the country has become a net external debtor for around 2% of GDP at end-2015 and that net external debt will continue rising in 2016.

The Republic of Congo's 'B' IDRs also reflect the following key rating drivers:

Weak development indicators, institutional framework (including public finance management and data quality) and business environment firmly entrench the rating in the 'B' category, as they exacerbate risks of economic shocks associated with high commodity dependence. Political risks, including potential tensions in the context of the 2016 presidential elections, are also high.

This exposure to shocks is to some extent mitigated by the country's membership of the franc zone, which has historically ensured a supportive macro and external environment, reflected in lower and less volatile inflation (2.5% on average over the past five years) than usually seen at the 'B' level. The unlimited guarantee provided by the French Treasury to support the peg at times of FX scarcity also reduces the risk of a balance of payment crisis.

Medium-term economic prospects remain positive. Non-oil activity (still dominated by public investment) has maintained real GDP growth in positive territory at around 2% in 2015 despite falling oil production. Important oil fields will come on stream in 2016-2017, which could increase oil production significantly, and no projects have been cancelled so far. The country has important, untapped mining potential, and the focus of the government on economic diversification could help support non-oil growth over the medium term.

RATING SENSITIVITIES
The main factors that could lead to a downgrade are:
- Depletion of remaining fiscal and external assets.
- Failure to consolidate fiscal accounts leading to a worsening in public and external debt dynamics.
- Delays in raising oil production.

The Outlook is Negative. Consequently, Fitch does not currently anticipate developments with a material likelihood of leading to an upgrade. However, the following factors could lead to a stabilisation of the Outlook:
- Material improvement in fiscal accounts, including faster-than-expected budget consolidation, stabilisation of external assets and public debt.
- Better public finance management, resulting in better budget transparency, reduction in domestic and external arrears and rising non-oil revenues.

KEY ASSUMPTIONS
Fitch assumes Brent oil prices of USD35/bbl in 2016 and USD45/bbl in 2017.

Fitch assumes that President Denis Sassou Nguesso will be re-elected at the March 2016 presidential elections, resulting in stability in the overall governance standards and business environment.

Fitch assumes no break-up of the CEMAC monetary zone and no devaluation of the CFA franc.

Fitch assumes the authorities will secure an official financing programme if needed.

Fitch assumes that legal claims regarding arrears to suppliers, including long-standing claims by Commisimpex, will not disrupt the sovereign's external debt service.