Fitch says IMF deals ease frontier market pressures; compliance key

Support from the IMF has helped to mitigate external liquidity risks and reduced the medium-term default risks in several frontier markets that entered into new programs in 2016, Fitch Ratings says. However, potential improvements in sovereign credit profiles will depend on each country’s level of compliance with IMF conditions, and implementation risks are often high.

In the two years leading up to their IMF loans, Fitch took negative rating action on five of the eight sovereigns that entered Standby Arrangements or Extended Fund Facilities in 2016 – Iraq, Kenya, Sri Lanka, Suriname and Tunisia. 

Egypt’s Stable rating Outlook in the run-up to its program reflected existing reform efforts before the IMF became involved. Jamaica signed a successor agreement in November 2016, and will treat the available funds as precautionary. It had been upgraded by Fitch earlier in the year after making progress on reducing the fiscal deficit and strengthening international reserves accumulation under its previous IMF program. Cote d’Ivoire, which had been upgraded in 2015, signed a successor agreement in December 2016.

Two net commodity exporters - Iraq and Suriname - were among those that experienced negative rating actions before turning to the IMF. These sovereigns were among the commodity exporters that accounted for two-thirds of Fitch’s emerging-market downgrades in the last two years. In Iraq and Suriname, the drop in global commodity prices opened up wide fiscal and current-account deficits. 

A lack of currency flexibility was also a factor in pushing some frontier markets into IMF agreements. Egypt, Sri Lanka and Suriname all ran down foreign-exchange reserves at unsustainable rates trying to resist currency depreciation in a global environment of US dollar strength. However, they have allowed more flexibility since beginning discussions with the IMF, which has helped reduce pressure on their external balance sheets. 

Political upheaval has also been a theme. Iraq is involved in ongoing conflict with the Islamic State group, while government instability has paralysed parliament and led to mass protests. Egypt and Tunisia went through political revolutions in 2011, and both are still dealing with underlying tensions and security risks. 

IMF loans should alleviate external liquidity pressures and reduce the risk of sovereign default, particularly where IMF assistance has been supported by other multilateral assistance or has improved access to global bond markets. However, all of these countries still have either large current-account or fiscal deficits, or both. Reducing these vulnerabilities will be key to stabilising or improving their ratings. 

Jamaica provides one example of how an IMF program can be credit positive. Pakistan also managed to stabilise its economy after a period of loose fiscal and monetary policy during its three-year IMF agreement that ended in 2016. However, without sustained commitment from the authorities, long-standing weaknesses may remain unaddressed, and there is a risk that governments will back away from reforms in the face of public opposition. An example is Suriname, where a severe recession and inflation has contributed to the partial reversal and stalling of key reforms, delaying the second program disbursement. 

Mongolia, Zambia and El Salvador have announced their intent to seek IMF assistance, highlighting that further IMF loans are likely to be agreed with several other frontier markets in 2017. Conversely, the Angolan government last summer broke off talks with the IMF over a potential loan. The IMF halted disbursements to Mozambique last year after the government revealed previously undisclosed debt.