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News Excerpt:

Fitch Ratings has downgraded the Maldives' Long-Term Foreign-Currency Issuer Default Rating (IDR) from 'B-' to 'CCC+'.

More about the News:

• Usually, Fitch does not give outlooks for countries with a rating of 'CCC+' or lower.
• This downgrade is due to increasing risks from the Maldives' worsening financial and liquidity conditions.
• The country’s shrinking foreign reserves and growing external debt make it harder for the new government to meet its significant debt payments and maintain the currency’s value against the US dollar.

Decline in foreign reserves 

• The Maldives' foreign reserves are expected to remain under pressure, having fallen from USD 748 million to USD 492 million over the past year.
• This drop is due to a high current account deficit (CAD) and interventions by the Maldives Monetary Authority (MMA) to support the currency.
• Net foreign reserves, excluding short-term liabilities, are much lower at USD 73 million.

Reasons for Declining Foreign Reserve

• The ongoing reduction in monetary reserves is attributed to inflationary policies, which typically involve liquidity injections to offset reserve sales and stabilize interest rates.
• These policies result in outflows exceeding inflows in the balance of payments.
• As open market operations become more 'modernized,' the currency peg becomes increasingly vulnerable, potentially leading to social unrest and default.

High Debt Payment 

• Foreign-reserve coverage of external payments is projected to stay low at 0.9 months in 2024, far below the ‘B’ median of 4.2 months.
• The Maldives has USD 233 million in sovereign debt payments and USD 176 million in publicly guaranteed debt payments due in 2024.
• Total external debt servicing will rise to USD 557 million in 2025 and over USD 1 billion in 2026.

External Support:

• It is assumed that the Maldives will continue to receive financial support from other countries and international organizations due to its strategic importance and anticipated policy actions by the new government.
• The Sovereign Development Fund (SDF), which collects foreign-currency tourism taxes for US dollar bond payments, could help finance upcoming debt.
• However, the SDF currently has limited funds, holding only USD 54.4 million as of June 11, 2024.

External Imbalances:

• Fitch expects the Maldives' CAD to stay high at 19.7% of GDP in 2024, much higher than the peer median.
• This high CAD is due to significant public investment and reliance on imports of essential goods amid high commodity prices, leading to persistent US dollar shortages.

Fiscal Consolidation:

• The fiscal deficit is expected to decrease to 12.7% of GDP in 2024 and 11.0% in 2025 from 14.5% in 2023, thanks to stronger revenue from tourism, rationalized capital expenditures, and gradual subsidy and healthcare reforms.
• Subsidy reforms are set for late 2024, expected to save about 3% of GDP on average from 2024-2026.

Public Debt Ratio:

• General government debt is forecasted to rise from 109.4% of GDP in 2023 to 117.6% in 2026, more than double the median level of similar countries.
• Government-guaranteed debt fell to 14.0% of GDP in 2023 from 16.3% in 2022, but the substantial guaranteed debt remains a risk to the country's financial stability.

Way Forward:

• In its latest review, the International Monetary Fund advised the Maldives Monetary Authority against printing money if it aims to maintain the currency peg.
• To repay foreign debt or create foreign reserves, domestic investments and consumption from current inflows must be reduced at suitable interest rates in order to reduce investment or consumption-driven imports.
• Fitch expects the government to reduce its need for external financing in the medium term through fiscal reforms.