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Rating Action:

Moody's affirms Solomon Islands' B3 rating; maintains stable outlook

03 Oct 2019

Singapore, October 03, 2019 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Solomon Islands' local and foreign currency long-term issuer ratings at B3 and maintained the stable outlook.

The affirmation of the B3 issuer rating is underpinned by Moody's assessment that support from development partners and ongoing fiscal reforms will continue to underpin Solomon Islands' fiscal strength and sovereign credit profile, although Moody's expects the government's debt burden to increase over the next few years. This is weighed against Moody's expectation for economic resiliency to remain very low given the small size of the economy, low incomes, as well as structural and institutional constraints that will take time to address.

The stable outlook reflects balanced risks. On the upside, the ongoing implementation of major infrastructure projects may raise private investment beyond Moody's current expectations, in turn raising the country's economic potential, competitiveness, and/or diversification prospects. On the downside, slowing global and regional growth and/or political volatility that threatens the implementation of fiscal reforms and sound macroeconomic policies may result in a wider fiscal deficit, higher government debt and higher liquidity risk relative to Moody's current projections.

Solomon Islands' long-term local currency bond and deposit ceilings are unchanged at B2. The long-term foreign currency bond and deposit ceilings are also unchanged at B2 and Caa1, respectively. The short-term foreign-currency bond and deposit ceilings are unchanged at Not Prime. These ceilings typically act as a cap on the ratings that can be assigned to the obligations of other entities domiciled in the country.

RATINGS RATIONALE

RATIONALE FOR RATING AFFIRMATION

SUPPORT FROM DEVELOPMENT PARTNERS AND ONGOING FISCAL REFORMS UNDERPIN FISCAL STRENGTH AND CREDIT PROFILE

Solomon Islands' B3 rating is underpinned by the country's fiscal strength, which reflects the substantial financial support from development partners that has resulted in low government debt and high debt affordability relative to similarly rated peers. Although Moody's expects the government debt burden to double by 2023, still-substantial financial assistance from development partners, combined with ongoing fiscal reforms, will continue to support the sovereign's fiscal strength and credit profile.

The implementation of large infrastructure projects, particularly the Tina River Hydropower Project (TRHDP), will raise debt levels over the next few years. TRHDP will cost around 18% of 2019F GDP, although a sizeable share of grant funding reduces the government's debt exposure to around 13% of 2019F GDP. Moody's expects construction for the project to commence at the beginning of 2020 and take five years to complete. Based on Moody's assumption that the drawdown of loans will be spread out over the construction period, Moody's expects the government's debt burden to double to around 20% of GDP by 2023 from around 10% of GDP as of the end of 2018. However, consistent with the country's high fiscal strength, government debt as a share of GDP will continue to remain lower than similarly rated peers and debt affordability will remain high, as all of the debt funding will be from international financial institutions at concessional terms.

Ongoing fiscal reforms have the potential to further mitigate the impact of borrowing for infrastructure investment on the government's debt burden and debt affordability. The government is aiming to introduce a new public financial management (PFM) regulation next year aimed at administrative changes that would raise revenue efficiency, tighten procurement procedures, and improve the process of multi-year budgeting. The government is also considering simplifying the tax structure, for example through the introduction of a value-added tax that would replace current import and export duties and goods and services taxes. The fiscal reforms are being designed and implemented with significant support from development partners. If effective, the measures would raise fiscal efficiency and hence government revenue.

These measures are in addition to efforts to reduce discretionary spending in the form of Constituency Development Funds (CDFs), which fell to around 1.2% of GDP in the 2019 budget from as high as 4-5% of GDP over the past five years.

Moreover, grant funding available to the government will increase over the next decade relative to 2018 levels. In particular, Australia has recently committed an additional AUD250 million (14% of 2019F GDP) in grants for infrastructure development in Solomon Islands, spread over 10 years. This is in addition to the AUD2 billion in loans and grants under the "Pacific step-up" that Australia has announced for the South Pacific region.

Larger amounts of grants will allow the government to meet its development spending needs while aiming for balanced budgets. Moody's expects an average government fiscal deficit of around 1-1.5% of GDP over 2019-23.

Narrow fiscal deficits, in combination with loan disbursements exceeding these deficits, will also allow the government to build up cash balances. Cash balances have increased to around 1.3 months of recurrent spending, thanks in part to the government's windfall revenue last year that resulted in a fiscal surplus of around 4% of GDP. Moody's expects the enhancements to PFM to limit the scope for cash balances to fall to low levels that will threaten government liquidity. Further mitigating government liquidity risk is the size of assets at the Solomon Islands National Provident Fund, which are mostly invested domestically and are sufficient to cover more than 3 times the government's debt burden as of the end of June 2019.

ECONOMIC RESILIENCY LIMITED BY SMALL SIZE OF ECONOMY, LOW INCOMES, AND STRUCTURAL AND INSTITUTIONAL CONSTRAINTS THAT WILL TAKE TIME TO ADDRESS

Balanced against Solomon Islands' fiscal strength is its low economic resiliency. This reflects the small size of economy, very low incomes, reliance on a depleting natural resource, and exposure to environmental risk. Structural and institutional constraints also weigh on economic competitiveness, government effectiveness and hence diversification prospects. Moody's expects ongoing technical support from development partners to mitigate the impact of some of the institutional challenges and the major infrastructure projects, when completed, to partly address the economic constraints. That said, Moody's also expects the improvements to economic and institutional strength to take time to emerge, and unlikely before the major projects are fully implemented.

Solomon Islands' economy is second smallest among the sovereigns that Moody's rates, and wealth levels are among the lowest. The country is also reliant on declining timber resources. The forestry industry contributed an average of around 1 percentage point to real GDP growth over the past five years, and exports of round logs made up two-thirds of exports over this period. Meanwhile, Solomon Islands is highly exposed to environmental risks given its topography. The economic limitations compound the impact of climate change-related natural disasters on the sovereign credit profile, and Moody's does not expect these limitations to ease over the next five to ten years.

The government is aiming to gradually reduce the country's reliance on the logging industry, with output converging towards sustainable levels more than 50% below the 2018 levels. Should the government meet its targets for the logging industry, this would have a modest negative impact on real GDP growth, although increased construction activity -- in large part related to TRHDP -- will partly offset any decline in logging output over the next few years. Moody's expects real GDP growth to decline to 2.5% in 2019 due to lower logging activity but pick up to 3.0-3.5% over 2020-23 as construction activity rises.

Longer term economic prospects depend on the Solomon Islands' economic competitiveness and diversification potential. Moody's assesses these to be currently constrained by structural limitations. Economic constraints include limited access to internet that is also slow and expensive; high cost of electricity and still-limited coverage; as well as poor transport infrastructure. Institutional constraints include low administrative capacity and coordination challenges that are common to small, narrowly diversified economies; underdeveloped regulatory frameworks and standards, and poor data quality that complicate investment decisions; as well as a volatile political environment that is prone to corruption and distracts policymakers from longer-term policies or reform measures.

Moody's expects the planned completion of the undersea cable project by the end of 2019 and TRHDP to address some of the economic constraints. Improved internet connectivity can increase public sector efficiency, raise productivity levels, and allow new sectors to develop, while TRHDP will significantly increase the electricity supply available to Honiara, the country's capital and economic centre, and substantially lower the cost of electricity across the archipelago given uniform tariffs countrywide, reducing the cost for businesses.

Ongoing assistance from development partners, including through secondments and staffing of key positions by international experts and the provision of technical expertise, also support the smooth functioning of government.

That said, Moody's expects the structural constraints to only gradually ease over time. The benefits to economic competitiveness and diversification prospects will slowly materialise as/when the key projects are completed and/or when investment responds to the reduced constraints. Institutional capacity building and enhancements to regulation and data quality will also take time. This leaves the sovereign credit profile vulnerable to shocks given Moody's expectation for still-low economic resiliency over the next five to ten years.

RATIONALE FOR THE STABLE OUTLOOK

The decision to maintain the stable outlook reflects balanced risks to the B3 rating.

On the upside, the ongoing implementation of major infrastructure projects may crowd-in investment in larger amounts or at a faster pace than Moody's current expects, which would raise the country's economic potential, competitiveness, and/or diversification prospects.

On the downside, slowing global and regional growth may have a larger impact on Solomon Islands' growth prospects than currently assumed. Political volatility, given the fragmented parliament, may also threaten the implementation of fiscal reforms and sound macroeconomic policies. These would potentially result in a weaker budget balance and government debt trajectory and higher liquidity risk relative to Moody's current projections.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

As mentioned above, environmental considerations are material to Solomon Islands' issuer rating. The topography of the small island archipelago and dependence on the forestry and agriculture industries expose the economy and government finances to the physical impact of climate change.

Governance considerations are also material to the rating. In particular, control of corruption remains a challenge with issues of transparency and leakages surrounding CDFs, while government effectiveness ranks one of the lowest among sovereigns rated by Moody's.

As regards social considerations, Solomon Islands' poverty rate and low level of resource utilisation stem in part from limited access to basic infrastructure such as roads, education, electricity and the internet. These challenges will be partly addressed through major infrastructure projects underway or in the pipeline, albeit gradually over time.

WHAT COULD CHANGE THE RATING UP

Upward pressure on Solomon Islands' rating would develop if economic competitiveness and/or prospects for diversification were to materially increase beyond Moody's current expectations. These may, for instance, be the result of greater confidence that ongoing infrastructure investment will lower the cost of doing business. A significant strengthening in institutional capacity and government effectiveness, possibly through long-term programmes with development partners, would also put upward pressure on the rating.

WHAT COULD CHANGE THE RATING DOWN

Downward pressure on the rating would emerge if renewed fiscal slippages and/or administrative lapses were to result in a worsening fiscal deficit and government debt trajectory and/or liquidity strains beyond Moody's current expectations. Political volatility that threatened the implementation of fiscal reforms, sound macroeconomic policies and/or engagement with development partners would also put downward pressure on the rating.

GDP per capita (PPP basis, US$): 2,242 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3.9% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 3.2% (2018 Actual)

Gen. Gov. Financial Balance/GDP: 3.9% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -4.2% (2018 Actual) (also known as External Balance)

External debt/GDP: 30.7% (2018 Estimate)

Level of economic development: Very Low level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 30 September 2019, a rating committee was called to discuss the rating of the Solomon Islands, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Christian Fang
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

No Related Data.
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