IHS upgrades Djibouti's short- and medium-term sovereign credit risk ratings over good external relations, economic prospects

IHS revised Djibouti's sovereign risk outlook to Positive from Stable in the 2015 fourth-quarter round, to signal an imminent ratings upgrade as additional foreign direct investment (FDI) inflows support economic prospects (see Djibouti: 2 February 2016: IHS revises Djibouti's sovereign credit risk outlook to Positive from Stable). Djibouti is set to make strong strides forward as it pursues its goals of steady economic growth and broader global alliances in the maritime trade and security spaces. Key factors in support of its current trajectory include:

• Strategic geographical location: The country continues to take advantage of its strategic location on East Africa's coast, specifically at the mouth of the Red Sea and also along the high-traffic Gulf of Aden maritime trade route. This makes it especially key to the Africa-Middle East-Asia economic trade and security nexus.
• Stable domestic security and political environment: Djibouti enjoys a remarkable degree of peace, despite being surrounded by Somalia, Eritrea, and Ethiopia, who are all facing some degree of political repression or instability, recurrent bouts of insecurity and insurgency, or piracy issues.
• Strong ties with Ethiopia: Djibouti provides critical coastal access as it is the main trading port for landlocked Ethiopia, Africa's second most populous country. It continues to benefit from strong economic and diplomatic ties with Ethiopia's government, which flourished as a result of the Eritrea-Ethiopia border dispute (ongoing since the last war between both countries ended in 2000, despite the United Nation's efforts to mediate negotiation talks).
• Growing global military significance: Djibouti is home to a number of key global foreign bases – including the United States' largest Africa base as well as France's largest deployment of Foreign Legions. China is now constructing its first foreign military base, raising Djibouti's already profile as a key security play even higher (see Djibouti: 2 March 2016: Construction begins on Chinese military base in Djibouti). Also, Saudi Arabia has expressed interest in establishing a military base in the country.

To achieve its economic ambitions, Djibouti is expanding its key infrastructure with projects estimated by reports at up to USD14 billion. Major transport-sector investments include: USD3 billion for a liquefied natural gas port, USD550 million for the Addis Ababa-Djibouti railway (partly supported by Chinese financing), expanded port facilities with USD300 million for the Doraleh Container Terminal and USD525 million for a multi-purpose port, and USD450 million for the Chabelley Airport and Cargo Village (Phase 1). Planned investments in water and energy are estimated at USD563 million and include a water pipeline with Ethiopia, a water desalination plant, and geothermal energy infrastructure. According to the International Monetary Fund (IMF) in its end-December 2015 review, aggregate investment is projected to "peak at 57% in 2015-2016". However, the strain of this is reflected on its fiscal and external balances.

Outlook and implications

IHS has upgraded Djibouti's sovereign credit risk ratings this quarter. This move lifts Djibouti's short-term rating one step higher in the investment grade category to 25/100 (A-, Good Quality). Also, our new medium-term rating of 55/100 (B+, High Payments Risk) reflects an improved rank in the speculative grade category. We maintain our Positive outlooks for both risk ratings. Djibouti's economic outlook remains bright, and both our current real GDP growth forecast of 4.1% for 2016 and medium-term growth trajectory could be revised upwards in the coming months. The sovereign's liquidity position continues to benefit from FDI inflows, rents from foreign military base operations and rising services, income, and transfers from the Port of Djibouti's growing operations. Also in its favour, Djibouti appears to have a very strong net foreign-exchange (FX) asset position. The IMF estimated that FX assets of commercial banks provided about 8.7 months of import cover in 2015, and projected an increase to over 10 months from 2016 onwards. IHS views this FX as a potentially supportive buffer, despite being held abroad, and thus raises the sovereign's profile for counterparty and financial business opportunities with BIS banks. Also, Djibouti's currency board arrangement provides "full currency board coverage over the period 2015–20" as a result of strong central bank gross foreign assets per the IMF.

Djibouti's economic prospects remain favourable as large-scale infrastructure development are slated to continue over 2017–19, supported by both foreign direct investment (FDI) and public spending. Nevertheless, we expect fiscal and external imbalances to persist, and serve as major constraints to the sovereign's credit ratings while exposing it to downside risks. On the fiscal side, we currently forecast a wider overall general government deficit of 14.5% of GDP for 2016, but this should moderate to 11.6% of GDP by 2018 as the bulk of investment-related spending steadily declines. On the external front, we project the current-account deficit to stay in double-digit territory over the near to medium term. Although capital goods for investment projects will continue to drive strength in imports, we anticipate that FDI inflows of about 5% of GDP will comprise about three-fifths of the current-account deficit with the remainder covered by loans. However, space for sizable non-concessional borrowing is limited without increasing debt distress risks given the country's high external debt load – estimated by IHS in 2015 at just less than 66% of GDP and slightly over 150% of foreign-exchange earnings. Djibouti has a history of debt arrears, in both interest and principal. However, the IMF reports that they are presently relatively low at around 2% of total external debt (1% of GDP).

Djibouti's government continues to build strong diplomatic and political relations with the international community. IHS expects this to yield positive dividends for the sovereign going forward. Its position (by virtue of its stability and geographic location) as a key ally to major Western powers in their fight against Islamic terrorism in Africa and parts of the Middle East, especially Yemen, mitigates – to a reasonable degree – any sovereign default risk. Indeed, we do not currently expect this, and foresee a willingness of external creditors to engage in negotiations to avoid a "hard landing" for Djibouti should this event arise.