Fitch Revises Dominican Republic’s Outlook to Positive; Affirms ‘B+’ Ratings

NEW YORK

Fitch Ratings has affirmed the Dominican Republic’s long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘B+’. The Rating Outlooks on the long-term IDRs are revised to Positive from Stable. The issue ratings on the Dominican Republic’s senior unsecured foreign and local currency bonds are affirmed at ‘B+’. The Country Ceiling is affirmed at ‘BB-‘ and the short-term foreign currency IDR at ‘B’.

KEY RATING DRIVERS

The Positive Outlook on the Dominican Republic’s long-term IDRs reflects the continued positive economic performance relative to peers, the reduction of external vulnerabilities, and progress on gradual fiscal consolidation.

The Dominican services-based economy has surpassed previous growth expectations and is expected to remain robust at 5.1% for 2016-2017. Diversification into tourism, higher value manufacturing, and recently mining has supported the economy’s resilience through economic cycles. In 2015, Fitch expects robust 6.2% demand-led growth. The wealth effect of the low oil price plus external receipts stimulate private consumption, complemented by the expansionary fiscal stance. Private housing and tourism investment has spurred construction along with government investment in two coal plants. This high growth is achieved without evidence of macroeconomic imbalances.

Inflation has declined and is expected to average 2.4% and 3.2% in 2015 and 2016, respectively, driven by the low oil price. Relative exchange rate stability supports the convergence of inflation expectations toward the midpoint of central bank’s 4%+/-1% target band. Challenges to consolidating the inflation-targeting regime introduced in 2012 include central bank operational losses, rapid imported-price pass-through, and financial dollarization.

Fitch expects the current external deficit will narrow to 2.3% of GDP on average for 2015-2017 and 1.1% of GDP average surplus after net FDI. While the low oil price is expected to endure, external accounts’ sensitivity to international oil prices could decline over the medium term as the electricity sector substitutes coal and renewable power. CXR growth is supported by U.S. demand for tourism and manufactured exports and remittance transfers. FDI averaging 4% of GDP per year over 2015-2017 is expected into tourism, telecoms, and manufacturing. External financing needs have narrowed close to 80% of international reserves for 2015-2017, down from over 100% in recent years.

The Dominican Republic’s external balance sheet remains vulnerable with limited buffers. The sovereign has a large net external debtor position with 70% of public debt denominated in foreign currency. The stable exchange regime has limited shock absorptive capacity. External liquidity is weaker than ‘BB’ and ‘B’ peers, as liquid external assets cover less than 100% of maturing external liabilities and increased non-resident capital market participation. These factors are balanced by the expected favourable trends in the balance of payments and lower commodity dependence than ‘B’ peers.

Fitch expects the general government will render a 2.6% of GDP deficit in 2015. The government is using oil-price savings to bring an estimated 0.4%-of-GDP of power plant investment on budget in 2015 while meeting its primary surplus objective.

In addition to the government’s 2016 deficit target, Fitch incorporates 1.2% of GDP power plant investment in the 3.6% of GDP overall general government deficit forecast for 2016, reflecting half the remaining capital investment (for 2016-2017) for which the legislature approved financing in 2015. Renewed international capital market access since 2010, development of the domestic yield curve since 2009–both supported with active debt management–and multilateral credits provide the government financing flexibility.

Public finance weaknesses place government debt on a sustained upward trajectory. Although general government debt is currently lower than peers, Fitch expects it will rise to 39% of GDP in 2017. Faster fiscal consolidation is hindered by the narrow tax base, rigid wages and salaries, and rising non-discretionary expenditure from electricity-sector transfers and interest bill–20% of revenue in 2015–from financial losses of the central bank and electricity generators.

The risk of material fiscal slippage repeating in the 2016 electoral cycle appears to have lessened, in Fitch’s view. While the proposed fiscal pact has not yet materialized, several factors signal likely fiscal restraint, including the expected primary fiscal surplus in 2015, limited pipeline of infrastructure projects, and buoyant economy. President Danilo Medina (PLD) has strong approval ratings but the long election cycle could turn competitive in the months ahead. The governing PLD has struck an alliance with the PRD forming a large election block for the May 15, 2016 polls and secured congressional passage of a constitutional amendment restoring consecutive presidential terms. Electricity sector reform is likely to remain atop the policy agenda in 2016-2017.

The Dominican Republic’s ratings are further underpinned by the country’s higher per capita income and social indicators than peers, its service-based economy, and improving debt management. These credit strengths are balanced by the weak structure of public finances, large net sovereign external debtor position with limited external buffers, and shallow albeit developing domestic capital market.

RATING SENSITIVITIES

The main factors, individually or collectively, that could lead to a positive rating action are:

–Continued strong investment and growth performance relative to peers without increasing macroeconomic imbalances;

–Sustained fiscal discipline that enhances the credibility of fiscal policy;

–Reduction of external balance sheet vulnerabilities;

The rating Outlooks are Positive. The main factors that could see the ratings revert to a Stable Outlook are:

–Fiscal slippage or growth underperformance leading to a material increase in government debt burden;

–Deterioration of external liquidity or increased macroeconomic imbalances;

–Emergence of financing constraints.

KEY ASSUMPTIONS

The ratings and Outlooks are sensitive to a number of assumptions:

–Fitch forecasts that average U.S. growth of 2.4% in 2015-2017 will support the Dominican Republic’s economic growth and external accounts, given the strong trade and financial linkages between the two countries.

–The Dominican Republic’s fiscal and external forecasts assume that annual gold production is sustained at 1 million ounces and international prices average USD1075 per ounce in 2016-2017, benefiting exports and mining royalties. Fitch’s latest projections also factor in adjustment of the average Brent oil price to USD55 per barrel in 2015 and USD60 in 2016, maintaining reductions of the country’s fuel import bill and electricity transfers.

–Fitch assumes that the normalization of monetary policy rates in the U.S. proceeds in an orderly manner and there are no large capital outflows or external market financing constraints for the Dominican Republic in 2015-2017.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Country Ceilings (pub. 20 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869287

Sovereign Rating Criteria (pub. 12 Aug 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=754428

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=995693

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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