Rwanda's economic growth prospects are stronger than peers', in our view, supported by robust investment levels of about 25% of GDP. AC Investment Inc.






Despite planned fiscal expansion, we expect government debt levels will remain moderate and debt-servicing costs will remain relatively low.

We are therefore raising our long-term sovereign credit rating on Rwanda to 'B+' from 'B', and assigning a stable outlook.


Rating Action

On Aug. 9, 2019, S&P Global Ratings raised its long-term sovereign credit rating on Rwanda to 'B+' from 'B'. The outlook is stable. At the same time, we affirmed our short-term sovereign credit rating at 'B'. We also revised the transfer and convertibility (T&C) assessment to 'B+' from 'B'.

 Outlook

 The outlook is stable because we expect Rwanda will continue to achieve above-average real GDP growth over the medium term, balanced against risks of fiscal slippages and rising government debt.

 We may lower the rating over the next year if the government's investment program significantly increases external financing requirements and external debt above our current projections. We could also see downward pressure on the rating if higher fiscal deficits lead us to reassess Rwanda's management and sustainability of public finances. An additional downward trigger could be if the Ebola crisis currently in the Democratic Republic of Congo (DRC) significantly impacts Rwanda's economy and exports.

Although we do not see further ratings upside in the near term, we may raise the rating in the medium term if the external outlook improves substantially, possibly as a result of government policies to diversify exports. We could also raise the rating if income levels rise more rapidly than our current projections.

Rationale

Rwanda has demonstrated strong GDP growth and above-average growth trends per capita than peers. We expect high growth will be driven primarily by public investment, which will likely result in sizable fiscal deficits and rising government debt levels. Nevertheless, Rwanda's track record of delivering inclusive growth through government-financed projects and broader macroeconomic initiatives remains reasonably sound. We also anticipate that ongoing economic and developmental reforms will underpin gradually rising private sector activity (albeit from a low base) and sustain foreign direct investment inflows and remittances.

One of our key assumptions supporting the rating is that a large portion of the higher fiscal deficits will be funded through concessional sources with long maturities, keeping funding costs low.

The rating on Rwanda remains constrained by its low GDP per capita of less than $1,000, which is one of the lowest among sovereigns that we rate, and the government's relatively high rate of debt accumulation since 2012 to fund infrastructure projects. We also note that debt held by state-owned enterprises (SOEs) has rapidly increased over the past two years and stood at about 7% of GDP at year-end 2018. If the pace of SOE debt accumulation continues, we could reassess contingent liability risks for the government. We expect that external debt net of liquid assets will reach to about 150% of current account receipts (CARs) by 2022.

 Institutional and economic profile: Political and institutional stability support stronger economic growth momentum

Rwanda has a strong record of implementing balanced macroeconomic policies, and we expect the government will balance higher public investment without substantially increasing debt levels.

The political landscape remains dominated by President Paul Kagame and his political party, which has provided political and institutional stability. However, decision-making is centralized and succession processes are uncertain and untested.

We expect real economic growth will average 7.4% over 2019-2022.

President Paul Kagame and his party, the Rwanda Patriotic Front, have dominated the political landscape since the end of the civil war in 1994. Ongoing political stability has allowed Rwanda to embark on a transformation of its economy with the support of international donors, with considerable success, although from a low level of economic development. We note, however, that Rwanda's political system has not yet been tested in a succession process. In our base-case scenario, we assume that the current government will continue its policies to support poverty reduction, improve the business environment, and gradually shift to private- from public-sector-led inclusive economic growth.

Rwanda continues to benefit from strong international donor support, although it is shifting increasingly from direct budget support in the form of grants to concessional funding and project financing. The IMF also approved a new three-year unfunded policy coordination instrument program, following the end of the previous unfunded policy support instrument in December 2018. The new program increases room for public spending on the government's national strategic transformation priorities, which include improving education quality, upgrading infrastructure in urban centers, and increasing agricultural productivity.

During 2018, real GDP increased by 8.6%, higher than our initial estimate of 7.1%, supported by a ramp-up in construction projects and strong performance in manufacturing, agriculture, and services. We have revised upward our growth forecasts, based on the government's revised medium-term spending trajectory.

In our view, a number of factors support Rwanda's growth prospects. There is a strong pipeline of construction projects, which includes the first phase of the new Bugesera International Airport (about $400 million, or about 4% of 2019 GDP), along with other infrastructure projects such as roads, energy projects, schools, and health centers. These projects will also drive manufacturing activity, particularly for metals and construction materials. We also expect growth in agriculture and related industries to be supported by investment to boost the sector's resilience to adverse weather-related shocks, as well as a focus on increasing the value added from the sector through agro-processing, washed coffee, specialty teas, and horticulture exports. Government efforts to formalize the mining sector should, in the medium term, increase productivity and processing of traditional minerals (tin, tungsten, and tantalum) and nontraditional minerals, such as gemstones.

Downside risks to our economic projections include weather-related events, such as droughts and floods; regional political developments, including a re-closure of the borders with Uganda (affecting especially consumption goods imports into Rwanda); and a potential spread of Ebola into Rwanda from the DRC.

Flexibility and performance profile: Higher government spending will result in higher fiscal and current account deficits relative to 2017-2018

We expect higher fiscal deficits, and forecast rising government debt to GDP over the next four years, although the debt burden compared with peers' remains moderate.

We expect that the current account deficit (CAD) will increase to about 10% of GDP on average over 2019-2022, but remain below the peak levels of 16% in 2015-2016.

We anticipate external debt will continue rising as the government moves away from grant financing toward concessional loans and project financing.

The government has revised its fiscal stance, with a focus on using available concessional funding to help meet developmental objectives and drive growth. We now expect fiscal deficits to average 5.6% of GDP over fiscal years 2019-2022, relative to our previous forecast of 4.6%. Beyond our forecast horizon, the government aims to restrain growth in investment spending by increasing private sector involvement. During fiscal 2019 (ended June 30, 2019), we estimate the fiscal deficit reached 5.5% of GDP, up from 4.8% in fiscal 2018.

We note that the fiscal trajectory relies on continued access to concessional external financing. Inadequate funding sources could limit or delay investment plans and temper growth, while reducing the deficit. Rwanda continues to face significant infrastructure shortfalls, which add to fiscal pressures, and capital expenditure makes up about 40% of spending.

To balance higher spending, the government is looking to improve domestic resource mobilization. In 2018, the government passed new laws on property tax, income tax, and transfer pricing to broaden the tax base. We expect some fiscal gains to accrue from measures to improve tax collection and compliance, including electronic billing machines, which should offset the impact of other tax-exemption policies aimed at promoting domestic production of imports. Yet, increased spending will still lead to significant borrowing requirements.

The government has stepped in to support some public enterprises directly from the budget through net lending estimated at about 2% of GDP. About 1% of GDP is subsidy support to RwandAir for its operational and capital expansion, and the rest of the net lending includes support to export-promotion activities, cement producer Cimerwa, as well as to the Kigali Convention Center (KCC) and the Marriot Hotel for their debt-servicing costs. We understand that the government plans to continue supporting these entities, with net lending projected to remain stable as a percentage of GDP over the next three years.

Rwanda's gross general government debt as a share of GDP has increased rapidly since 2012, due to large infrastructure projects, reaching an estimated 49% of GDP at year-end 2019. We forecast net government debt levels rising to 50% of GDP by 2022 from 41.5% in 2018. A high proportion of government debt--80% in 2018--is in foreign currency, and we expect the proportion to increase slightly. In our view, this increases the risk to debt sustainability from sharp exchange rate depreciation. We project, however, that the government's interest expenditure will remain relatively low, at about 6% of revenue, reflecting Rwanda's continued access to financing on favorable terms from multilateral development institutions, such as the World Bank and the African Development Bank. Over the medium term, we expect domestic funding to increase in line with ongoing government efforts to develop domestic capital markets.

We currently assess the government's contingent liabilities as limited, but we could worsen our assessment if existing trends continue. SOE and government-guaranteed debt increased to almost 7% of GDP at year-end 2018 from 1% in 2015. RwandAir held debt of 2.6% of GDP, KCC held about 2%, and about 1.2% were loans for the Bugesera International Airport project. We understand that the financial performance of the airline and KCC remains weak, requiring government support to meet debt-servicing needs. The government has also provided domestic debt guarantees to the hotel and insurance sectors of about 1% of GDP.

The government intends to keep its stake in the Bugesera International Airport at 25%, and expects the remaining project spending will come from the private sector. However, delays in private sector financing could result in increased government involvement and liabilities, given the project's strategic nature.

External pressures have eased since 2016 as the CAD narrowed due to lower capital imports following the completion of some of the largest construction projects, including the KCC and several new high-end hotels (for example, Marriott and Radisson Blu), and the purchase of two planes by RwandAir in 2016. At the same time, higher transfers and growth in nontraditional exports, such as minerals (particularly in 2017), horticulture, and leather, helped strong growth in exports. As a result, the CAD decreased to an average of 7.8% of GDP over 2017-2018 relative to 14.4% over 2014-2016. We forecast the CAD will increase over 2019-2022 to an average of 9.5% of GDP, mainly due to increasing capital imports for the airport's construction and other infrastructure projects.

At the same time, we expect a negative impact on exports from the temporary closure of the border with the DRC on Aug. 1, 2019, due to three fatalities from Ebola in Goma. About 10% of Rwanda's exports and 85% of re-exports are to the DRC. Notwithstanding this impact, we anticipate that exports will continue increasing, while growth in imports will eventually moderate, as government efforts under the "Made in Rwanda" campaign to support domestic production through import substitution and to promote value-added exports start to yield results. At the same time, service exports should be supported by higher tourism receipts. Nonetheless, external financing needs will remain high, and we forecast that they will average around 110% of CARs and usable reserves over 2019-2022.

We expect that the CAD will be funded mainly through rising government concessional borrowing, along with private sector commercial borrowing and foreign direct investment. We expect that the share of multilateral and bilateral foreign grants will decline marginally, and we project external debt increasing above external liquid assets to about 150% of CARs by 2022, from an estimated 124% in 2019. Our current assumptions reflect the government's medium-term debt strategy through 2021, which favors maximizing external concessional borrowing over short-term domestic securities to meet government financing needs.

From January 2019, the National Bank of Rwanda (BNR) transitioned to an interest rate-based monetary policy framework from a reserve money-based one. The transition could help improve monetary policy effectiveness over the longer term, if the development of interbank and domestic capital markets strengthens. We believe the BNR will continue an accommodative monetary policy to support private sector credit growth and given low inflation pressures. In May 2019, the BNR reduced policy rates by 50 basis points to 5%. Inflation fell significantly to 1.4% in 2018 from 4.9% in 2017 on the back of lower supply pressures amid a rebound in the agriculture sector. We expect that inflation will remain around 5% through 2022, which is the BNR's medium-term target.

In our view, Rwanda's banking system remains broadly stable, with total domestic banking system assets at about 38% of GDP, but there could be vulnerabilities. The banking system's nonperforming loans stood at 6.4% of total loans at year-end 2018, down from 7.6% at year-end 2017. There could be some concentration risk through the banks' exposure to the hotel and construction sectors, which could materialize if the tourism sector faces difficulties.