Seychelles: Upgrade from 6 to 5 for medium- to long-term political risk
Further improvement since the 2008 balance-of-payments crisis
During 2008, Seychelles experienced a severe balance-of-payments crisis with foreign-exchange reserves depleted because of low tourism earnings and high import payment obligations. Public debt also rose strongly given the structurally large public deficits, which averaged 6% of GDP in the period 2000-2007. In the course of 2008 the public debt level was already unsustainable. As a significant share of public debt was funded externally, the devaluation of the currency at the end of 2008 pushed the debt further to unsustainable levels.
In response to this the then still socialist government decided to loosen its grip on the economy, committed itself to an IMF programme and became a more market-oriented economy. A steady consolidation of public finances was implemented and in order to bring public debt back to a sustainable level it also obtained debt rescheduling and forgiveness in 2009 and 2010. This led to an upgrade of Credendo’s medium-/long-term political risk classification in 2015. However, since the upgrade in 2015, the economic and financial situation has continued to improve on the back of continued consolidation of public finances and implementation of economic reforms.
Political stability since moving to a democracy
The political situation in Seychelles has remained stable in recent years. It is a former British colony that became independent in 1976. The year after independence, Seychelles became a dictatorship when Prime Minister France-Albert René seized power through a successful coup d’état and made the Seychelles People’s Progressive Front (SPPF) the sole legal party. This lasted until 1992 when, under pressure from France and Great Britain, Seychelles was transformed again into a multi-party democracy. However, the SPPF, which was renamed the People’s Party (Parti Lepep – PL), remained the dominant political party and Albert René remained President until 2004, when James Michel took over. In the years following the handover of power the PL continued to win both the parliamentary and the presidential elections, although the opposition was able to gain more votes with each election. Therefore, the dominance of the PL lasted until September 2016, when the opposition Linyon Demokratik Seselwa (LDS) coalition won a majority of the seats during the parliamentary elections. With the LDS controlling the parliament there has not been a structural break policy wise. Following the loss of the parliamentary majority, President James Michel announced his resignation and handed over power to his Vice President, Danny Faure, who is also a member of the PL and has remained President since then.
Reforms under the guidance of multiple IMF programmes
Economic reforms have been implemented under the guidance of the IMF. Seychelles has performed well under multiple IMF programmes since 2007. Most recently, in 2017, a three-year Policy Coordination Instrument (PCI) was launched. One the main focuses of the reforms has been the continued consolidation of public finances. Since the crisis in 2008, Seychelles has continued to run a significant primary surplus. More recently, the primary surplus in the 2015-18 period decreased but still averaged 3.5% of GDP. This led to a reduction of the public debt-to-GDP ratio from almost 70% of GDP in 2015 to around 60% of GDP at the end of 2018. Almost half of the total public debt is held externally, but this external share has decreased over the years as it represented around 60% in 2010. The aim of the PCI programme is to bring the public debt-to-GDP ratio below 50% by 2021. While this target is achievable for Seychelles, it should be noted that in 2015 it was predicted that it would be achieved by the end of 2018. In the coming years it is expected that Seychelles will continue to run primary surpluses. This should be achievable even as it continues with the large infrastructure programme that should further develop the tourism industry, public infrastructure and the country’s resilience to climate change.
Given the reduction of the public debt level, public interest payments have been decreasing. While Seychelles spent around 10% of its total government revenue on interest payments in previous years (and a much larger share in the years before the 2008 crisis), this share decreased to 8.4% in 2018 and is projected to steadily decrease further in the coming years. Nevertheless, the gross financing needs of the government remain large, mainly due to the short maturity of domestic public sector debt. While the government has almost no short-term external public debt, most domestic public debt has a maturity of less than one year. This is an issue that the government plans to tackle in the medium term by steadily lengthening the maturity of domestic public debt. Another potential risk to public finances is the fact that a number of state-owned enterprises (SOEs) have relatively large external liabilities. While the liabilities do not benefit from an explicit government guarantee, the government has taken over some liabilities in the past (e.g. the external liabilities of Air Seychelles in 2012). In recent years Seychelles has responded to this by increasing the oversight of SOEs and has committed itself in the light of the IMF programme to do this further in the coming years.
One of Seychelles’ main weaknesses is its size. The country has only around 0.1m inhabitants and it is an extremely open, tourism-dependent economy. GDP and total exports only amount to around USD 1.5bn. The island nation remains heavily dependent on imported goods (most importantly, fuel and food). For its export receipts, it depends more than a third on tourism receipts and almost 20% on the export of canned tuna. Although this dependency has decreased slightly in recent years compared to the historic average, these sectors are expected to remain the dominant source of export receipts in the medium term. Given the large import need, Seychelles runs a large current-account deficit. Historically this has been around 20% of GDP. In 2018 it was reduced to 18% and currently it is projected to remain around 18% in the medium term. However, it is very positive to see that historically around 70% of the current-account deficit has been funded through significant FDI inflows, mainly in the tourism sector.
Due to the size of the Seychellois economy, the country is vulnerable to internal as well as external shocks. History has shown that loosening domestic policy can quickly destabilise Seychelles’ open economy. For example, the large wage increases in 2014 fuelled import demand and, as a result, the current-account deficit widened. Losses in state-owned enterprises (SOEs) in 2011-2012 also translated quickly into external pressures as public debt increased. Therefore, this remains one of the drivers for Seychelles in the medium/long term.
External debt levels have been on the decline
The debt relief received in 2009 and 2010, together with the structural tightening of public finances, has reduced external debt levels, as the external debt level to current-account receipts ratio stood at close to 110% in 2018. This is a medium/high level for a country such as Seychelles and is a further reduction compared to 2015, when it stood at about 120%. The external debt-to-GDP ratio is, however, relatively high as it stands at around 100% and has remained stable in recent years, although it is projected to decrease. Around a third of Seychelles’ external debt consists of public external borrowing. This is mainly borrowing from official sources at favourable interest rates and maturity. Another third of the external debt is related to foreign investments in the country by the tourism sector; within this part there is a significant share of intercompany loans.
Given the large share of lending from official creditors, Seychelles’ external debt service is relatively low. In 2018 it spent only around 5% of total current-account receipts on servicing external debt. In the coming years too the external debt service is expected to remain low.
The main risk to Seychelles’ debt position is its exposure to possible currency depreciation. This could push up the debt-to-GDP ratio significantly. At the same time the risk is mitigated first of all by the fact that while the tourism sector has significant external liabilities, its income is also in foreign currency, which mitigates part of the risk. Secondly the vulnerabilities should decrease over time with the continued implementation of fiscal consolidation, as has already happened to a large extent in past years. In addition, while Seychelles has a floating exchange rate, the currency has remained relatively stable. The Central Bank only occasionally intervenes in the foreign-exchange market in order to smooth out fluctuations. Seychelles’ foreign-exchange reserves are sufficiently large and have remained stable in recent years. In March 2019 they were sufficient to cover around 3.7 months of imports.
Significant uncertainties related to climate change lie ahead
A key risk for Seychelles is its exposure to the consequences of climate change, most importantly the consequences of rising sea levels and extreme weather events. This has already been evident in the past, when heavy rainfall in the 1990s led to significant damage to the economy, especially in the fisheries and agriculture industries. Furthermore, rising sea levels impacted Seychelles in May 2007, when high tides led to flooding up to 50 m inland. However, as the country lies outside the cyclone belt, it is less exposed to potential extreme natural disasters that impact among others a number of Caribbean islands on a recurring basis.
In terms of impact on GDP in recent years the biggest natural disasters in Seychelles have been the 1997 flood, which had an estimated cost of around 0.5% of GDP, the 2004 tsunami, which had a cost of 3.6% of GDP, and the 2013 tropical storm, which had an estimated cost of 0.7% of GDP. According to an assessment by the IMF, Seychelles is the 26th most vulnerable country out of 33 small islands in terms of the risk of extreme natural disasters. This index captures the frequency of disasters and the effect these disasters had over the period 1950-2014. Its position is mainly explained by Seychelles’ geography and location.
At the same time the country itself is also able to deal with the adverse consequences of climate change for a number of other reasons. First of all, thanks to the strong fiscal consolidation effort in recent years, Seychelles has freed up fiscal space that could be used to deal with the potential cost of a natural disaster. The IMF estimated in 2017 that Seychelles would be able to deal with a natural disaster that imposes a cost of 10% of GDP on the economy, while at the same time a much larger shock could still be problematic. Secondly, Seychelles has developed adaptation plans to deal with the consequences of climate change, namely by setting out investment needs for coastal management, although at the same time this remains very much a work in progress and large investments will still need to be made in the coming years. The exposure to climate change combined with the small size of the economy are also a clear driver of medium-/long-term risk in Seychelles.
Analyst: Jan-Pieter Laleman – email@example.com