Fitch Upgrades Ethiopia’s Domestic Credit Rating Amid Economic Reforms

In a significant development for Ethiopia’s financial landscape, Fitch Ratings announced an upgrade of the country’s Long-Term Local-Currency Issuer Default Rating (LTLC IDR) to ‘CCC+’ from ‘CCC-‘ on October 25, 2024, signaling a cautious optimism toward Ethiopia’s economic restructuring. While the Long-Term Foreign-Currency IDR remains at ‘Restricted Default’ (RD), Fitch’s upgrade of the local currency rating highlights Ethiopia’s gradual easing of financial pressures and ongoing macroeconomic reforms.

Economic Policy Reforms Boost Confidence

The move reflects Ethiopia’s renewed efforts to address long-standing economic imbalances, starting with the National Bank of Ethiopia’s (NBE) recent market-based determination of the national exchange rate. This policy, introduced in July 2024, led to over 50% depreciation of the official exchange rate, aligning it with the parallel market and alleviating distortions that had hampered trade. The NBE also introduced an interest-rate-based monetary policy, setting a 15% policy rate to stabilize inflation and enhance the effectiveness of monetary policy.

The changes follow Ethiopia’s new four-year agreement with the International Monetary Fund (IMF) under the Extended Credit Facility, which immediately disbursed $1 billion as part of a $3.4 billion package to support Ethiopia’s economic adjustments. The arrangement, alongside anticipated funding from the World Bank totaling $3.75 billion, is expected to reduce Ethiopia’s reliance on domestic financing and enable a shift toward market-based auctions for treasury bills.

Local Debt Management and Fiscal Balancing

Fitch also noted Ethiopia’s intention to phase out non-market-based local financing, which had contributed to financial repression and inflation. In a related move, the NBE converted ETB242 billion in direct advances to long-term government securities, easing rollover risks. The NBE’s initiative to conduct regular open-market operations is a key step in creating a sustainable fiscal framework.

The government’s shift toward managing its debt more sustainably is evidenced by a narrowing of its fiscal deficit from 2.5% of GDP in FY23 to 2% in FY24. Fitch projects a slight increase to 2.7% in FY25 due to government spending on essential social programs and public sector wage increases.

Foreign Debt Restructuring Remains Key Challenge

Despite the positive trajectory in local currency management, Ethiopia’s external debt challenges persist, with the foreign-currency IDR at RD. Ethiopia is restructuring $15.1 billion of external debt through the Common Framework, which began in 2021 and includes both bilateral and commercial debt. A standstill agreement with major Chinese creditors and the Official Creditor Committee (OCC) granted Ethiopia relief on debt service for 2023 and 2024. Progress toward an agreement with the OCC is expected by the end of 2024, a crucial step before Ethiopia begins negotiations with private creditors.

Future Outlook and Potential for Improvement

Fitch has outlined conditions for further positive rating action, indicating that a resolution of Ethiopia’s foreign-currency debt restructuring and successful implementation of economic reforms could lead to further upgrades. The alignment of official and parallel exchange rates has boosted gold exports, contributing to an expected rise in international reserves from $1 billion in FY24 to an anticipated $4.5 billion by FY26.

However, challenges remain, particularly in political stability and institutional transparency, which impact Ethiopia’s credit profile. Fitch’s ESG scores highlight governance concerns, particularly in terms of rule of law and corruption control, underscoring the need for continued progress in these areas to solidify Ethiopia’s path to economic stability.

In conclusion, while the upgrade to ‘CCC+’ marks a positive step for Ethiopia’s local-currency obligations, the nation faces a delicate balancing act as it seeks to achieve sustainable growth and meet the conditions of international creditors. The journey is ongoing, but Fitch’s assessment reflects growing confidence in Ethiopia’s reform agenda and economic potential.